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Profit-Sharing Plan

Reviewed by Vineeth | Updated on Sep 30, 2020

Catalogue

Introduction

A profit-sharing plan is a pension plan, which gives an employee a share in the company’s profits. As per this plan, which also referred to as the deferred profit-sharing plan (DPSP), employees will go onto receive a portion from the company’s profits which depend on the annual or quarterly earnings.

This is an excellent option for businesses to provide their employees with discernment of the ownership over the company they are working for. This will push them to pump up their performance and can produce great results in the long run. However, there will be several restrictions as to when the employees will be able to withdraw these funds with no penalties.

Breaking Down

A profit-sharing plan is a regular pension or retirement plan which will receive contributions from the employer. This actually means that a retirement plan such as the employees’ provident fund (EPF) and national pension system (NPS) is not an example of the profit-sharing plan as it involves contributions being made from the compensation that the employees earn.

As employers are going to set up profit-sharing plans, the organisation will decide as to how much they would like to allot to every employee. A firm which will provide a profit-sharing plan is going to adjust it as required.

There are instances of employers sometimes making zero contributions. In those years in which the employer will go onto make a contribution, the organisation should come up with a defined formula to payout the profits to its employees.

Calculation

The most popular method for an organisation to calculate the profit-sharing allocation is by making use of the comp-to-comp strategy. By making use of the method to calculate profits, the company will first determine the overall compensation of its employees. Then, the organisation will determine the individual compensation and profits of every employee.

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