Definition
A profit-sharing plan is a formal arrangement established by a company to distribute a portion of its profits to its employees. The company makes discretionary contributions to individual employee accounts typically based on its profitability for that year. These contributions can be in the form of cash or placed into a deferred plan, which may include investments in stocks, bonds, or other financial instruments. The accumulated funds in these accounts usually grow on a tax-deferred basis until the employee retires or leaves the company. Many profit-sharing plans also permit employees to take loans against their accounts for significant life expenses, such as buying a home or funding education.
Examples
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TechCorp Annual Bonus: TechCorp has a profit-sharing plan where 10% of annual profits are distributed among employees based on their salary levels and tenure within the company.
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Retail Inc. Deferred Plan: Retail Inc. contributes a portion of its yearly profits into a deferred profit-sharing plan. The resources are invested in a diversified portfolio of equities and bonds. These funds grow tax-deferred and can be accessed by employees upon retirement.
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Manufacturing Co. Loan Feature: Manufacturing Co. allows employees to borrow up to 50% of their profit-sharing account balance for major expenses like buying a new home or covering college tuition fees for their children.
Frequently Asked Questions
1. How is the contribution to a profit-sharing plan determined?
The contribution is typically determined as a percentage of the company’s annual profits, with the specific formula often established in the plan document.
2. Are contributions to a profit-sharing plan tax-deductible?
Yes, contributions made by the employer to a profit-sharing plan are generally tax-deductible to the employer.
3. When can employees access the funds in their profit-sharing accounts?
Employees can often access the funds in their profit-sharing accounts upon retirement or separation from the company. Some plans may also allow for earlier withdrawals or loans under specific conditions.
4. Can employees contribute to a profit-sharing plan?
Profit-sharing plans are typically funded solely by employer contributions, though some may allow for employee contributions or matching.
5. What happens to the profit-sharing account if an employee leaves the company?
The handling of the account depends on the plan’s vesting schedule and provisions, but generally, the employee retains control of their vested portion.
Related Terms
**1. Vesting: Refers to the process by which an employee earns the right to receive full benefits from the profit-sharing plan after a certain period of employment.
**2. 401(k) Plan: A retirement savings plan sponsored by an employer allowing employees to save and invest a portion of their paycheck before taxes are taken out.
**3. Deferred Compensation: A portion of an employee’s compensation that is set aside to be paid at a later date, typically to gain tax advantages.
Online Resources
Suggested Books for Further Studies
- “Employee Benefits Design and Planning: A Guide to Understanding Accounting, Finance, and Tax Implications” by Bashker D. Biswas
- “401(k)s FOR DUMMIES” by Ted Benna and Brenda Watson Newmann
Fundamentals of Profit-Sharing Plan: Management Basics Quiz
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