A profit-sharing plan is a type of retirement plan where employers can contribute a portion of the company’s profits to their employees.
What is a profit-sharing plan?
- A profit-sharing plan is a retirement plan where employers can share the profits of a company directly with their employees.
- Employers contribute entirely to the plan, but their contributions are discretionary.
Employers contribute the full amount paid to employees. However, there is no guarantee that the employer will make regular contributions to employees as their contributions are discretionary. Additionally, the company doesn’t need to earn a profit for the year to contribute to the plan.
If employers choose to provide contributions through the profit-sharing plan, they must determine a method or formula for how much each employee should receive. This will start with the company allocating what percentage of the profits they want to distribute to all employees through the plan. Next, they need to determine how they want to distribute those allocated profits to their employees. A common practice is the “comp-to-comp” method. Through this method, the paid amount will depend on what the percentage weight of an employee’s salary has against the total sum of all employee salaries. The higher salary an employee has, the higher share of the profits they will receive.