Profit-sharing plans (also deferred profit-sharing plans) are defined contribution retirement plans that base contributions on a company’s profits or earnings. Companies do not determine contributions to profit-sharing plans exclusively by profit. Contributions to profit-sharing plans are made solely by employer (never employees) and are discretionary (determined by the company and inherently variable).
Although contributions to profit-sharing plans are discretionary, employers are typically required to use a set formula for contributions on behalf of employees. Comp on comp is a main method of determining the extent of a contribution made on behalf of an employee. With this method, a company calculates an employee’s salary as a percentage of the company’s total employee compensation package. This percentage is use to determine the employee’s share of the allocated earnings.
Employee participation in a profit sharing plan is not voluntary. In effect, you cannot choose a profit-sharing plan as your retirement plan- unlike the 401K or other defined contribution plans. In some cases, the profit-sharing plan may be the only retirement plan that a business offers. Otherwise, companies can use them with other retirement plans as an additional incentive for employees.
Like other retirement plans, profit-sharing plans have contribution limits per calendar year. Employers typically determine this by the greater of a percentage or a set figure for the calendar year. Relevant tax authorities determine the contribution limits, which are subject to change. Exceeding contributions limits can remove tax qualification in certain jurisdictions.
Profit-sharing plans exempt are generally tax deductible and there is tax-deferred treatment until full-withdrawal or maturity. Full-withdrawals are not normally permitted for profit sharing plans until the age of 59 . Other withdrawal restrictions or stipulations may be applicable to profit-sharing plans. In certain cases, employers also allow participant loans on them.
Unless profit-sharing plans are employee-directed, your company may not reveal how they allocate the investments or your stake in the fund. However, this information may be made available on a yearly basis. The accessibility of information depends on the number of employees that participate in the plan. However, many companies strive for transparency with plan information.
Profit-sharing plans offer greater flexibility, although they may favour high earners in a company. That they favour high earners is an additional merit for late-starters in retirement planning who are in that earning category. Profit-sharing plans are especially valuable if you are working with a successful company. Even though it is an involuntary retirement plan and you cannot contribute to it, you can choose other employer-sponsored retirement plans if they are available. A profit-sharing plan is not only a greater incentive for employees but also a welcome boost to your retirement income.