Profit-Sharing Plans are a type of variable pay plans that support a company’s retirement planning benefits or bonus structure. Simply put, the company contributes a percentage of the annual profits into a fund or trust. Then, the company disperses it to eligible employees either as a cash bonus or as a deferred retirement benefit. As a discretionary contribution fund, employers can decide whether they put money into the fund year-by-year. This makes it an attractive option for employers.
How Does a Profit-Sharing Plan Work?
When using profit-sharing as a retirement planning tool for employees, companies typically make their contributions to a qualified tax-deferred retirement account. This allows penalty-free distributions to employees after they reach the age of 59 ½ in the form of cash or stocks. Unlike a 401(k), participants in a profit-sharing plan don’t contribute – although the company can choose to maintain retirement planning options such as a 401(k)’s in addition to the profit-sharing plan. Upon leaving the company, employees are able to move their profit-sharing assets into a Rollover IRA.
Profit-sharing plans can also be a useful tool for a company’s bonus structure. In this case, the company foregoes the deferred aspect of the plan and instead distributes the contributions as cash bonuses – most often based on a percentage of the eligible employee’s salary.
Some companies choose to create a combination plan that offers both deferred retirement benefits and cash distributions, the latter of which is taxed as ordinary income during the year in which it was received by the employee.
What Are the Pros & Cons of Profit-Sharing Plans
Profit-sharing plans may be ideal for some companies and ill-suited for others, so it’s important to work with a qualified advisor to decide whether its right for you and your employees.
Pros– Profit-sharing can help build a team mentality because each employee has a vested interest in the company’s success. Whether they’re enjoying a bonus payout or a growing retirement fund, profit-sharing empowers each employee to understand how his or her role fits within the bigger picture.
The flexibility of the plan can be a great asset for employers, as contributions aren’t required if cash flow becomes an issue.
Cons– Using profit-sharing as a performance motivator may lose its impact over time as employees begin seeing the bonuses or contributions as an entitlement as opposed to an earned benefit. Additionally, employees aren’t able to differentiate how his or her individual work supported the goal achievement, which provides little incentive for improved performance.
Profit-sharing plans require significant administrative efforts, including creating official plan documents, ongoing record-keeping and reporting, and dispersing the funds according to predetermined guidelines. Keep in mind that a profit-sharing plan means you have a strict fiduciary responsibility to consider.
With over 35 years of experience, Hall & Company’s team of retirement planning experts and business consultants have guided countless companies in choosing the best options for their employee benefit plans. Contact us via email or call our offices at: 949-910-HALL (4255).