Profit Sharing

Profit Sharing

A plan by which an employer distributes a set percentage of the company's profits to its employees. Employers may distribute the portion of its profits immediately (that is, employees may receive what amounts to a bonus) or it may set up a series of accounts for employees and defer the profit sharing until employees retire. The idea behind profit sharing is to give employees an incentive to work for the company's profitability. See also: DPSO, ESOP.

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Profit sharing. A profit-sharing plan is a type of defined contribution retirement plan that employers may establish for their workers.

The employer may add up to the annual limit to each employee's profit-sharing account in any year the company has a profit to share, though there is no obligation to make a contribution in any year.

The annual limit is stated as a dollar amount and as a percentage of salary, and the one which applies to each employee is the lower of the two alternatives.

Employers get a tax deduction for their contribution. Employees owe no income tax on the contributions or on any of the earnings in their accounts until they withdraw money.

In some cases, employees in the plan may be able to borrow from their accounts to pay for expenses such as buying a home or paying for college.

Profit-sharing plans offer employers certain flexibility. For example, in a year without profits, they don't have to contribute at all. And they can vary the amount of each year's contribution to reflect the company's profitability for that year.

However, each employee in the plan must be treated equally. This means that if an employer contributes 10% of one employee's salary to the plan, the employer must also contribute 10% of the salaries of all other employees in the plan.