Profit Sharing Plans


What is a profit-sharing plan?

A profit sharing plan is a type of qualified defined contribution plan in which you, the employer, contribute to the accounts of participating employees. As the name applies, your employer contributions are generally (but not necessarily) tied to your business’s profits, allowing employees to “share” in those profits. Annual contributions to the plan may be discretionary (you need not contribute anything at all), or may be based on a specific formula relating to your annual profits.

Like other types of qualified plans, the purpose of a profit sharing plan is to help fund your employees retirement. By offering such a plan, you may be able to attract quality employees and reduce your employee turnover rate. Unlike some other types of qualified plans, however, a pure profit sharing plan is generally employer funded.

Your profit sharing plan is a tax deductible contribution that you, the employer, are the allowed to make cannot exceed 25 percent of the total compensation of all employees covered under the plan. For the purposes of calculating your maximum tax deductible contribution, the maximum compensation base that can be used for any one plan participant is $245,000 for 2010, and $245,000 for 2011.

Whether you are a large company, a small to medium company, or a sole proprietor, you can establish and maintain a profit sharing plan. Because of the flexibility in making contributions, a profit sharing plan is most beneficial if you are an employer whose profits or financial ability to contribute to a plan varies every year. In addition, you may find this type of plan to be especially appealing if you have many employees who are relatively young. Such employees generally have substantial time to accumulate retirement savings, and are often willing to accept some investment risk with their money in exchange for the potential of impressive investment returns over the long term.