- Profit sharing plans are qualified retirement plans. A qualified plan is one that must comply with the Employee Retirement Income Security Act. Companies seek qualified status for their plans in exchange for tax considerations for the company and the employees. To be qualified, a plan must demonstrate that it covers all employees equally. The plan also must show that benefits are given to participants in an acceptable and fair way, that the compensation used as a basis for the benefits is fair and that the plan's purpose is to benefit participants.
- In profit sharing plans, there doesn't need to be a formula that ties the contributions to company profits. For example, 10 percent of your annual salary might be used. Another common method is for the company to allocate a fixed amount. The firm might look at the payroll and calculate each employee's share. It is also common for companies to base this allocation on age and service.
- Often, a profit sharing plan exists as a part of a combined plan with a 401(k) plan. This means you might have two or more "buckets" of money in one account: profit sharing, 401k contributions and possibly a company matching contribution. The trend toward such combined plans is based mostly on employee requests. If a company offered a profit sharing plan, allowing employees to contribute their own salary doesn't add much cost, just administrative maintenance.
- A profit sharing plan typically requires the following providers:
1. A trustee, who could be a vendor, such as a bank or insurance company or some individual at the company.
2. A record keeper or third-party administrator to allocate contributions and account for changes in account balances, growth, distributions and new hires.
3. A lawyer to write the plan documents and keep them current. In some cases they sponsor a prototype plan that is less costly but also less flexible.
4. An investment provider. This could also be provided by the record keeper in a "bundled" arrangement, or through an unrelated set of mutual funds or separate accounts offered through the trustee. - Regardless of the type of contribution, no employee may receive contributions that exceed $49,000, for 2009. All funds contributed to your accounts are on a tax-deferred basis, meaning that they grow tax-free until you make a withdrawal. Then contributions and earnings are taxed as ordinary income. Profit-sharing plans and 401k plans form incentives for companies and employees to create savings for employees' retirements.
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