Profit-sharing is typically a type of retirement savings benefit offered by employers. Many small employers utilize this plan, as there is no requirement that it be funded every year. Profit-sharing by definition means an employer will share a portion of its profits with an employee at the end of a fiscal year. This can be paid out as cash or company stock. Often, profit sharing is offered as a benefit to retirement planning for employees.
Why Profit Sharing?
A set amount of money is distributed to the employees of a company. Sometimes, but not always, the amount is determined by the previous year’s success or lack thereof. In some cases, it is a benefit the employer guarantees while in others the employer can decide not to contribute from year to year. This allows the company to be fiscally responsible with their money. It is also motivational, as employees will be motivated to be successful to raise the likelihood of receiving their share in the next year.
How Does Profit Sharing Work?
A profit-sharing arrangement means the employer is exclusively contributing to this type of retirement account. Unlike a 401k with a percentage matched by the employer, the employee contributes nothing to this type of account. With that said, some companies offer both opportunities to their employees. The retirement contributions are made into tax-deferred accounts that can be withdrawn from after a specified age. Most companies base the contribution amount on the employee salary or their time served with the company. Like all tax-deferred plans, there are maximum contribution limits. In this case, it is $54,000 per year or 100% of the employee salary – whichever is less.
Profit-Sharing: Good or Bad?
As mentioned earlier, a plan like this rewards employees and can create flexibility for the employer to ensure the necessary cash flow to continue operating. Profit-sharing is a nice benefit that employees enjoy. The downside for employers is that it can be costly to keep up with these plans and can be challenging to create a profit-sharing program that does not seem to favor higher-paid employees. In the long run, retirement saving is essential, and any contribution made is beneficial for employees.