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What Is a Profit-Sharing Plan?

  • How It Works
  • Requirements

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  • Retirement Planning
  • Retirement Savings Accounts

Profit-Sharing Plan: What It Is and How It Works, With Examples

profit sharing plan definition business dictionary

Investopedia / Paige McLaughlin

A profit-sharing plan is a retirement plan that gives employees a share in the profits of a company. Under this type of plan, also known as a deferred profit-sharing plan (DPSP), an employee receives a percentage of a company’s profits based on its quarterly or annual earnings. A profit-sharing plan is a great way for a business to give its employees a sense of ownership in the company, but there are typically restrictions as to when and how a person can withdraw these funds without penalties.

Key Takeaways

  • A profit-sharing plan gives employees a share in their company’s profits based on its quarterly or annual earnings.
  • It is up to the company to decide how much of its profits it wishes to share.
  • Contributions to a profit-sharing plan are made by the company only; employees cannot make them, too.

Understanding Profit-Sharing Plans

So how does profit sharing work? Well, to start, a profit-sharing plan is any retirement plan that accepts discretionary employer contributions. This means a retirement plan with employee contributions, such as a 401(k) or something similar, is not a profit-sharing plan, because of the personal contributions.

Because employers set up profit-sharing plans, businesses decide how much they want to allocate to each employee. A company that offers a profit-sharing plan adjusts it as needed, sometimes making zero contributions in some years. In the years when it makes contributions, however, the company must come up with a set formula for profit allocation.

The most common way for a business to determine the allocation of a profit-sharing plan is through the comp-to-comp method. Using this calculation, an employer first calculates the sum total of all of its employees’ compensation. Then, to determine what percentage of the profit-sharing plan, an employee is entitled to, the company divides each employee’s annual compensation by that total. To arrive at the amount due to the employee, that percentage is multiplied by the amount of total profits being shared.

The most frequently used formula for a company to determine a profit-sharing allocation is called the “comp-to-comp method.”

Example of a Profit-Sharing Plan

Let’s assume a business with only two employees uses a comp-to-comp method for profit sharing. In this case, employee A earns $50,000 a year, and employee B earns $100,000 a year. If the business owner shares 10% of the annual profits and the business earns $100,000 in a fiscal year, the company would allocate profit share as follows:

  • Employee A = ($100,000 X 0.10) X ($50,000 / $150,000), or $3,333.33
  • Employee B = ($100,000 X 0.10) X ($100,000 / $150,000), or $6,666.67

The contribution limit for a company sharing profits with an employee for 2023 and $73,500 including catch-up contributions for those 50 or over during the year.

Requirements for a Profit-Sharing Plan

A profit-sharing plan is available for a business of any size, and a company can establish one even if it already has other retirement plans. Further, a company has a lot of flexibility in how it can implement a profit-sharing plan. As with a 401(k) plan, an employer has full discretion over how and when it makes contributions. However, all companies have to prove that a profit-sharing plan does not discriminate in favor of highly compensated employees .

As of 2023, the contribution limit for a company sharing its profits may not exceed the lesser of 100% of your compensation or $66,000. This limit increases to $73,500 for 2023 if you include catch-up contributions. In addition, the amount of an employee’s salary that can be considered for a profit-sharing plan is limited, in 2023 to $330,000.

To implement a profit-sharing plan, all businesses must fill out an Internal Revenue Service Form 5500 and disclose all participants of the plan. Early withdrawals, just as with other retirement plans, are subject to penalties, though with certain exceptions .

Is a Profit-Sharing Plan the Same As a 401(k)?

No, a profit-sharing plan is not the same thing as a 401(k). With a profit-sharing plan, a company gives employees a portion of the profit based on quarterly or annual earnings. With a 401(k), employees are making personal contributions. In some cases, a company will partially match an employee's 401(k) contribution.

What Are the Different Types of Profit-Sharing Plans?

With a cash plan, employees are given either cash or stock on a regular basis, such as quarterly or annually. The payouts are quick, relative to a retirement plan, but they are also taxed as regular income. A deferred plan sees profits set aside for a later date, usually when the employee retires. The employee is also not taxed until retirement. Some plans combine elements of both a cash and a deferred plan.

How Do Employers Determine Contribution Amounts to a Profit-Sharing Plan?

Employers typically use one of two methods to determine contribution amounts. With a comp-to-comp method, the total amount of compensation given to all employees is calculated. Next, each employee's compensation is divided by the total compensation, yielding a percentage that establishes each employee's portion of the profit. The higher an employee's salary, the greater the percentage of the profits that the person receives. Less commonly, a company may give the same percentage of profits to every employee, regardless of that employee's salary. 

A profit-sharing plan is a way for employers to provide employees with a portion of the business's profits, based on quarterly or annual earnings. Contributions are given out on a regular basis, or are put into a fund that is made available at a later time, such as when the employee retires.

A profit-sharing plan is funded entirely by the employer, and is therefore different from a 401(k), which is primarily funded by the employee. Profit-sharing plans are generally seen as a meaningful way to motivate employees, by directly connecting the company's success to the employees' increased compensation.

Internal Revenue Service. " Choosing a Retirement Plan: Profit-Sharing Plan ."

Internal Revenue Service. " A Guide to Common Qualified Plan Requirements ."

Internal Revenue Service. " Retirement Topics - 401(k) and Profit-Sharing Plan Contribution Limits ."

Internal Revenue Service. " Form 5500 ,"

Internal Revenue Service. " Form 5500 Corner ."

Internal Revenue Service. " Hardships, Early Withdrawals and Loans ."

profit sharing plan definition business dictionary

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profit sharing

Definition of profit sharing

Examples of profit sharing in a sentence.

These examples are programmatically compiled from various online sources to illustrate current usage of the word 'profit sharing.' Any opinions expressed in the examples do not represent those of Merriam-Webster or its editors. Send us feedback about these examples.

Word History

1872, in the meaning defined above

Dictionary Entries Near profit sharing

profit motive

profit system

Cite this Entry

“Profit sharing.” Merriam-Webster.com Dictionary , Merriam-Webster, https://www.merriam-webster.com/dictionary/profit%20sharing. Accessed 15 Feb. 2024.

Legal Definition

Legal definition of profit sharing, more from merriam-webster on profit sharing.

Britannica.com: Encyclopedia article about profit sharing

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What Is a Profit-Sharing Plan?

profit sharing plan definition business dictionary

  • What Are Profit-Sharing Plans?

How a Profit-Sharing Plan Works

Profit-sharing plans vs. 401(k)s.

  • Rules for Profit-Sharing Plans

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A profit-sharing plan is a type of defined contribution plan that allows companies to help their employees save for retirement. Employers use these plans to give their workers a stake in the company's success. It's also a nice benefit that can be used to attract new hires.

Key Takeaways

  • A profit-sharing plan is similar to a 401(k) plan but more flexible for the employer.
  • A business does not have to make contributions to the plan in years that it’s not profitable.
  • Employees do not have to make their own contributions to profit-sharing plans. Businesses with these plans are sharing any profits they've earned with their workers.
  • Workers can take profits in the form of cash or company stock . 

Definition and Example of Profit-Sharing Plans

Profit-sharing plans are a way for a company to share profits with its workers. Contributions are discretionary. The company can decide how much it will put into the plan from year to year. It can even decide not to contribute at all. This flexibility makes it a nice option for both small and larger businesses. A profit-sharing plan aligns the financial well-being of workers with the company's success.

A company doesn't have to make contributions to a profit-sharing plan if it doesn't make a profit, but it doesn't have to be profitable in order to provide workers with this type of plan. Unlike 401(k) plan participants, workers with profit-sharing plans don't make their own contributions. A company can offer other types of retirement plans , such as a 401(k), along with a profit-sharing plan.

A company can legally exclude certain employees from the plan, including nonresident aliens, those who are younger than age 21, and those who are covered by collective bargaining agreements that don't provide for participation. Employees with a short tenure can also be excluded. It depends on the plan.

Employees who are age 21 or older cannot be excluded from a profit-sharing plan because of age.

Employees can receive their shares of profits in the form of cash or company stock. Contributions are often made to a qualified tax-deferred retirement account . These accounts allow penalty-free distributions after age 59 1/2. Some plans offer both deferred benefits and cash. The cash is taxed at ordinary income rates.

A combination of deferred benefits and cash acts like a retirement contribution plus a yearly bonus.

You can move assets from a profit-sharing plan into a rollover IRA if you leave your job, but you can be subject to a 10% tax penalty if you take a distribution before age 59 1/2. A worker might be able to take a loan from their plan while still employed.

A salary-deferral feature added to a profit-sharing plan would define that plan as a 401(k). There are a few differences between the two.

Profit-sharing plans and 401(k)s both help workers save and plan for retirement, but they are structured differently. One distinction is how the company contributes to the employee's savings effort: whether at a pre-set rate or based on company profits. While profit-sharing plans are funded fully by the employer, 401(k) plans are funded primarily through the employee's own earnings.

Both types of plans have rewards for businesses, as well. Happy workers tend to stay put for the long term, and plans that employers fund generously can also entice new talent into signing on.

Requirements for Profit-Sharing Plans

There's no set amount that a company must put into its profit-sharing plan each year, but there is a limit on the amount that can be made for each worker. This limit changes over time with inflation. The maximum contribution for a profit-sharing plan is the lesser of 25% of compensation or $61,000 in 2022, up from $58,000 in 2021.  

There are also limits on the amount of your pay that goes into figuring out contributions. The limit is $305,000 for the 2022 tax year, up from $290,000 in 2021.

If the employer decides to make a contribution in a given year, it must follow a set formula to determine which workers get what, and how much they receive.

How Will Your Employer Determine Your Share?

Many employers use the "comp-to-comp" method of figuring out how much an employee will get. With this method, your employer would add up its total compensation spending for the year. Then, it would divide each employee's amount by the total to determine their share of the total pool.

For instance, suppose that your employer has a total compensation budget of $1,000,000. It decides to create a profit-sharing pool of $100,000. Your yearly compensation is $50,000.

The formula to figure out your share would look like this:

In other words, you would get 5% of the profit-sharing pool. Your share would be $5,000.

Other Requirements for Profit-Sharing Plans

Contributions can also vest over time, according to a set vesting schedule .

An employer must set up a system that tracks contributions, investments, and distributions. It must also file a yearly return with the government. These plans can require a good deal of administrative upkeep.

Internal Revenue Service. ” Choosing a Retirement Plan: Profit-Sharing Plan .” Accessed Nov. 10, 2021.

U.S. Department of Labor. " Profit-Sharing Plans for Small Businesses ." Page 4. Accessed Nov. 10, 2021.

U.S. Department of Labor. ” FAQs About Retirement Plans and ERISA .” Page 9. Accessed Nov. 10, 2021.

U.S. Department of Labor. " Profit-Sharing Plans for Small Businesses ." Page 1. Accessed Nov. 10, 2021.

Internal Revenue Service. “ Retirement Topics—401(k) and Profit-Sharing Plan Contribution Limits .” Accessed Nov. 10, 2021.

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profit sharing plan definition business dictionary

What Is Profit Sharing, and How Can it Benefit Your Business?

Looking to offer your employees an additional benefit? Consider creating a profit-sharing plan. But before you run off and create a plan, you need to know what is profit sharing. Read on to learn all about profit sharing, including how it works and steps for creating a plan of your own.

What is profit sharing?

Profit sharing is a type of pre-tax contribution plan for employees that gives workers a certain amount of a company’s profits. The profit-sharing payments depend on the:

  • Business’s profitability
  • Employee’s regular wages and bonuses
  • Amount set by the business

With a profit-sharing plan (PSP), employees receive an amount based on the company’s earnings over a specific period of time (e.g., a year). Generally, an employee receives a percentage or dollar amount of the business’s profits either in cash or company stock. Many businesses offer profit sharing as a retirement benefit for employees.

If an employer does not make a profit during the time period (e.g., year), they do not have to make contributions that year.

Typically, a business offers a PSP to help instill a sense of ownership in its employees. The goal of a small business profit-sharing plan is to reward employees for their contribution to the company’s success and incentivize employees to keep reaching goals.

PSP vs. 401(k)

Although a profit share agreement can be used as a retirement plan option to offer employees, it’s not the same as a 401(k) plan.

Both plans give employees additional retirement benefits. However, 401(k) plans and PSPs have different rules and structures.

With 401(k) plans, employees can make contributions to their own plans. And depending on the type of 401(k) plan, the employer might make a matching contribution.

With a PSP, an employee cannot make any contributions. Only the employer can make a contribution to the PSP. But, a company can offer other types of retirement plans , such as 401(k), along with a PSP.

What is profit sharing? Profit sharing is a type of pre-tax contribution plan for employees that gives workers a portion of a company's profits.

Types of PSPs

There are a few different types of profit-sharing plans to choose from. They all follow the same concept: an employer sharing a portion of their profits with employees.

Here are the three types of PSPs:

  • Pro-rata : All employees receive the same contribution amount from the employer (e.g., percentage or fixed dollar). This is the most common type of PSP.
  • Non-comparability / cross-testing : Employers can contribute to different groups of employees (e.g., full-time employees) at different rates.
  • Age-weighted : Takes age and salary into consideration. Employers can offer older employees a higher percentage than younger employees because they are closer to a retirement age. With an age-weighted plan, the longer someone stays with the business, the more their employer contribution rate increases. This type is specific to PSPs used as retirement plans.

Requirements for a PSP

Businesses of any size can create a profit-sharing plan. If you use your PSP as a retirement benefit, you can also take advantage of other retirement plan types.

A business must also follow a predetermined profit allocation formula for deciding how much employees receive in profits and which employees are eligible.

There’s no set amount that a company must contribute to its PSP each year. But, there is a maximum contribution amount that you can make per employee. According to the IRS , the contribution limit for a company sharing its profits with an employee is the lesser of 25% of that employee’s annual compensation or $69,000 (2024).

Profit sharing example

Ready to see profit sharing in action? Let’s look at an example of profit sharing so you can see it first-hand.

To calculate the employer contribution, you need to add the compensation for all employees. Divide each employee’s individual compensation for the period by the total compensation for the period. Then, multiply your profit share percentage by your profits for the period. Finally, multiply the two totals together to determine each employee’s payment amount.

Say you have three employees. Employee A makes $30,000 per year, Employee B makes $25,000, and Employee C makes $40,000. The total compensation for all three employees is $95,000 ($30,000 + $25,000 + $40,000). This year, your business had a profit of $150,000, and you share 10% of your annual profits with employees. Take a look at how much each employee would receive:

Employee A: ($150,000 X 0.10) X ($30,000 / $95,000) = $4,736.84 Employee B: ($150,000 X 0.10) X ($25,000 / $95,000) = $3,947.37 Employee C: ($150,000 X 0.10) X ($40,000 / $95,000) = $6,315.79

To figure out your company’s profit-sharing amount per employee, you can use the following formula:

Profit-sharing amount = (Profits X Profit-sharing Percentage) X (Employee Compensation / Total Employee Compensation)

How to create a profit-sharing plan

To get started creating your PSP, follow the steps below:

  • Profit allocation formula
  • Percentage vs. dollar amount
  • Eligibility requirements
  • Amount (e.g., percentage or dollar amount)
  • Frequency (e.g., annual)
  • Provide information to eligible employees
  • Details your contribution plan and all participants in it
  • Keep records (e.g., amounts, participants, etc.)

Benefits and disadvantages of profit sharing

There are pros and cons to profit sharing. Before you start small business profit sharing, weigh the advantages and disadvantages.

Here are some benefits of a profit-sharing plan for businesses:

  • You can change how much you contribute year to year
  • Any business can start one
  • You can offer one in addition to other retirement plans
  • Plans boost employees’ commitment to the business for the long-term
  • It can be used to attract and retain top talent
  • The plan can motivate your team
  • Contributions are tax-deductible for employers

Check out some cons to a PSP:

  • Takes some extra work to get set up (e.g., filling out Form 5500)
  • Employer is subject to nondiscrimination testing
  • Employees can’t contribute
  • You may need to do some tweaking when calculating an employee’s pay
  • The plan’s only focus is profitability

Do your research and determine if the cons are worth it before you decide to follow the path of profit sharing.

This article has been updated from its original publication date of July 12, 2013.

This is not intended as legal advice; for more information, please click here.

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A profit-sharing plan is a retirement plan that allows an employer or company owner to share the profits in the business, up to 25 percent of the company’s payroll, with the firm’s employees. The employer can decide how much to set aside each year, and any size employer can use the plan.

The benefit to employees is that they could accumulate more than in a typical 401(k) plan . And for 2023 workers can receive up to a whopping $66,000 total or 100 percent of compensation, whichever is less, in employer-sponsored accounts. In addition, a $6,500 catch-up contribution may also be made by those age 50 or over in that tax year.

Here’s how a profit-sharing plan works, a comparison of the different kinds of plans available and the benefits of using these plans to reward employees.

How does profit-sharing work?

A profit-sharing plan is one of many different kinds of retirement plans offering employers a way to provide a benefit to employees. The plan can provide a lot of flexibility in how money can be distributed, though employers must abide by certain rules in how they administer the plan, in order to avoid discrimination.

For employees, that means they need to do nothing to participate in the plan or max out its benefits. The profit-sharing is, in effect, a bonus on top of any other retirement benefits.

The plan can be operated as a separate account or it can be a feature added to a 401(k) account, but either way it’s only the employer making contributions through the profit-sharing feature.

As a qualified retirement plan, the funds can be withdrawn without penalty after the employee turns 59 1/2, though withdrawals before that age are subject to a 10 percent penalty on top of any taxes owed. Withdrawal rules are similar to those for a traditional IRA , and participants will have required minimum withdrawals when they reach age 73.

From sole proprietors to large corporations, a company of any size can participate in the plan. Employers may decide how much to share with employees, up to 25 percent of their payroll during that tax year. The maximum amount of salary that can be used to figure the profit-sharing bonus is limited to $330,000 in 2023.

Employers are not obligated to use the program from year to year, allowing them to shut off the plan, if needed or desired. However, when the employer does make contributions, they must be made according to a predetermined formula, to ensure that the profits are divided legally.

Employers have flexibility in how benefits are distributed. Plans are tested annually to ensure that benefits are not being offered in a way that discriminates against employees, such as lower-level workers vis-a-vis managers and owners.

Like some other retirement plans, employers can require the funds to vest , meaning that employees must continue working at the company for a period of time before fully owning the funds. But once the employee owns the funds, they cannot be clawed back by the employer.

Types of profit-sharing plans

Profit-sharing plans come in a few varieties, but they’re all still fundamentally based on the employer providing money to the employee. The differences in these varieties involve how benefits are shared with employees, and the distribution schemes include:

  • Pro-rata plan – In this setup, everyone involved in the plan receives the same contribution from the employer. This could be a fixed dollar amount or percentage of salary.
  • Age-weighted plan – Under this plan, employers can consider how the profit-sharing would affect the employee’s retirement, taking age and salary into consideration. The net effect is that employers can offer older workers a higher percentage contribution than younger workers, because they have fewer years to retirement.
  • New comparability plan – In this plan, also called a cross-testing plan, the employer can contribute to different employee groups at different rates. This plan helps the employer reward different employee groups (including an owner) with various benefits, even if they have similar ages.

A pro-rata plan is the most standard choice, though it may be too rigid for many employers. The head of the company may receive 15 or 20 percent of compensation as part of the plan, meaning the lower-paid administrative staff must receive the same percentage.

“As a pure employee benefit, this works great, but most employers are not looking to give to everyone at the same levels,” says Mark Wilson, president of MILE Wealth Management in Irvine, California.

And that’s where the other plan types come in. An age-weighted plan allows the employer to provide higher benefits to older employees and to do so legally, within certain limits.

The new comparability plan offers a lot of flexibility for employers or owners who want to retain the most for themselves even while offering employees a benefit. It also gives them a way to contribute to employees at various rates based on criteria that are important to the employer.

“For employers, they need to be strategic about the levels of employees they determine for their plan,” says Tatiana Tsoir, CEO of Linza Advisors in Mount Kisco, New York. Employers are able to favor “highly compensated employees by setting them up in a different group,” says Tsoir.

That flexibility offers employers the opportunity to fine-tune their benefits.

“For example, a new comp plan might give 10 percent to the legal staff and 5 percent to the administrative staff,” says Wilson. “In the right circumstances, these plans can work out very well.”

Such new comparability plans are limited in the differential they can offer employees, however. They must offer all employees at least either 5 percent of pay or one-third of what the most highly compensated employee receives under the plan.

Benefits of using a profit-sharing plan

For employees, the benefit is obvious – it allows them to save more. But these profit-sharing payments aren’t subject to Social Security and Medicare taxes, so the net benefits are even larger to employees than a comparable taxable bonus. A profit-sharing plan may offer quite a few benefits to employers, too, especially relative to other retirement plans.

Productivity incentives

First, a profit-sharing plan may motivate employees to be more productive. If they understand that their work translates into a higher reward, they may think more like owners of the business.

It may also help attract and retain skilled employees, and the adept use of a vesting schedule may help encourage the talent to stick around longer.

Tax advantages

Employers also derive tax benefits from the profit-sharing plan. Contributions to a 401(k) with profit sharing are tax deductible, reducing the employer’s tax liability. Tsoir says that employers can decide as late as September of the next year and still get a deduction for the prior tax year.

While profit-sharing plans do require some annual testing and reporting requirements, they also “allow for vesting schedules, loan provisions, and different eligibility rules that are often better than plans like a SEP IRA,” says Wilson.

Advantages over other plans

A SEP IRA , another popular retirement plan option among smaller businesses, may be easier to set up and administer, but it requires the business to pay the same retirement benefit to all employees, offering little flexibility. It also lacks the ability to require vesting, a feature that may help employees remain with the employer longer.

Similarly, a SIMPLE IRA offers an easier way to set up a retirement plan with reduced reporting requirements. It too offers less flexibility in employer contributions and does not offer vesting. Also important to note, the amount an employee contributes to a SIMPLE IRA from their salary cannot exceed $15,000 in 2023. Those age 50 and older are permitted to make up to another $3,500 in catch-up contributions.

So, a profit-sharing plan can offer some notable advantages over other plans, and it can be set up as an add-on to a 401(k), making that plan the key hub for an employee’s retirement savings.

Bottom line

A profit-sharing plan offers employers a lot of flexibility when they decide to offer this benefit to employees, unlike some other retirement plans. Not only can employers turn off the benefit, if they need or want to, but they’re also able to more finely tune the benefits structure to reward certain employees more, even while taking a tax break for providing the benefits.

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Meaning of profit sharing in English

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  • anti-profiteering
  • anti-speculative
  • be a license to print money idiom
  • lose your shirt idiom
  • non-profit-making
  • out-of-pocket
  • profit from something
  • profit warning
  • trade surplus

profit sharing | Intermediate English

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What is profit sharing? Definition and examples

Profit Sharing involves giving employees a direct share of a company’s profits. It is an incentive plan that companies pay in addition to their workers’ salaries. The profit share may be in the form of money or stocks. In this context, the word stocks means shares.

There are many different types of profit sharing plans. Some companies share a percentage of their profits with all their employees. Others reward only some people, such as managers, salespeople, or directors, i.e., senior management.

Profit sharing image image 49494949494

“Profit sharing is an incentivized compensation program that awards employees a percentage of the company’s profits. The amount awarded is based on the company’s earnings over a set period of time, usually once a year.”

Profit sharing vs. employee bonuses

Some people mistakenly use the two terms interchangeably. Even though both refer to giving employees extra money on top of their salaries, their meanings are quite different.

Employee bonuses

Companies give certain employees bonuses as a reward for their work or achievements. For example, if the sales department reached its monthly or quarterly target, its members may receive extra money as a reward, i.e., a bonus.

Profit sharing

Profit sharing has nothing to do with an individual employee’s achievement, but rather on how well the company as a whole did that year. In this case, employees only receive the extra money if the company makes a good profit.

It only occurs after the business’ accountants and directors have determined how profitable the past year has been .

Gains sharing is a system that focuses on profits, productivity, and individual workers .

Pros and cons

As is the case with any system or plan, sharing a company’s profits with its employees has both advantages and disadvantages:

  • Employees feel that the company values them.
  • Workers appreciate the value of teamwork.
  • Each worker has a vested interest in the success of the business.
  • Everybody’s goals and objectives are more likely to be similar or the same.
  • Employees who know their team effort will be rewarded are likely to work harder.
  • Better employee retention, i.e., workers are less likely to leave the company.

Profit sharing resentment cons image 4949449494

  • It is not tied to individual effort or achievement.
  • The hardest working or most successful employees may resent others being rewarded equally for less work or lower achievements.
  • As it is not tied to individual effort, employees may eventually feel that profit sharing is an entitlement.
  • If workers think they are entitled, the whole plan loses its motivational factor.

Effective profit sharing plans require careful structuring to ensure they align with company goals and motivate employees appropriately.

Europe and the USA

Regarding what happens in Europe , Wikipedia informs:

“The share of profits paid to the management or to the board of directors is sometimes called the tantième. This French term is generally applied in describing the business and finance practices of certain European countries, including Germany, France, Belgium, and Sweden.”

In the US, there are various plans. For example, the company shares a percentage of profits with some or all employees, and contributes the money to their retirement plan. In many cases, they operate alongside 401(k) plans.

In the USA, profit sharing often serves as a supplement to retirement benefits, enhancing employees’ long-term financial security and investment in the company’s future.

Video – What is Profit Sharing?

This video, from our YouTube partner channel – Marketing Business Network , explains what ‘Profit Sharing’ means using simple and easy-to-understand language and examples.

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What Is Profit Sharing? Pros and Cons

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Profit sharing helps employees prepare for retirement by offering them a portion of the company’s profits. Who wouldn’t want that? While it does offer both employees and employers definite advantages, profit sharing also comes with some less obvious drawbacks. 

Key Takeaways: Profit Sharing

  • Profit sharing is a workplace compensation benefit that helps employees save for retirement by paying them a portion of the company’s profits if any.
  • In profit sharing, the company contributes a part of its profits into a pool of funds to be distributed among eligible employees.
  • Profit sharing plans may be offered in lieu of or in addition to traditional retirement benefits, like a 401(k) plan.

Profit Sharing Definition

“Profit sharing” refers to variable pay workplace compensation systems under which employees receive a percentage of the company’s profits in addition to their regular salary, bonuses, and benefits. In an effort to help its employees save for retirement, the company contributes a part of its profits into a pool of funds to be distributed among employees. Profit sharing plans may be offered in lieu of or in addition to traditional retirement benefits, and the company is free to make contributions even if it fails to make a profit. 

What Is a Profit Sharing Plan?

Company-funded profit sharing retirement plans differ from employee-funded profit sharing plans like 401(k) plans , in which participating employees make their own contributions. However, the company may combine a profit sharing plan with a 401(k) plan as a part of its overall retirement benefits package. 

Under company-funded profit sharing plans, the company decides from year to year how much—if anything—it contributes to its employees. However, the company has to prove that its profit sharing plan does not unfairly favor its highest-paid employees or officers. The company’s profit sharing contributions may be made in the form of cash or stocks and bonds. 

How Profit Sharing Plans Work

Most companies make their profit sharing contributions to qualified tax-deferred retirement accounts. Employees can begin taking penalty-free distributions from these accounts after age 59 1/2. If taken before age 59 1/2, distributions may be subject to a 10% penalty. Employees who leave the company are free to move their profit-sharing funds into a Rollover IRA . In addition, employees may be able to borrow money from the profit sharing pool as long as they are employed by the company. 

How Individual Contributions Are Determined

Many companies determine how much they will contribute to each employee’s profit sharing plan using the “comp-to-comp” or “pro-rata” method, which allocates a share of the profit based on the employee’s relative salaries. 

Each employee’s allocation is calculated by dividing the employee’s compensation by the company’s total compensation. The resulting fraction is then multiplied by the percentage of profit the company has decided to contribute to profit sharing to determine each employee’s share of the total company contribution.

For example, a company with total annual compensation of $200,000 to all of its plan-eligible employees decides to contribute $10,000—or 5.0%—of its net profit to the profit sharing plan. In this case, the contribution to three different employees might look like this:

Under current U.S. tax laws, there is a maximum amount a company can contribute to each employee’s profit sharing account. This amount changes depending on the inflation rate . For example, in 2019, the law allowed for a maximum contribution of the lesser of 25% of the employee’s total compensation or $56,000, with a limit of $280,000.

Distributions from profit sharing plans are taxed as ordinary income and must be reported as such on the employee’s tax return. 

The Pros of Profit Sharing 

Besides helping employees build toward a comfortable retirement, profit sharing makes them feel that they are working as part of a team helping the company achieve its goals. The assurance that they will be rewarded above and beyond their base salaries for helping the company prosper motivates employees to perform above and beyond minimal expectations. 

For example, in a company that only pays its salespersons commissions based on their individual sales, such a team spirit rarely exists, as each employee acts in his or her own best interest. However, when a portion the total commissions earned is shared among all of the salespersons, the more likely they are to function as a cohesive team.

The offer of profit sharing can also be a valuable tool in helping companies recruit and keep talented, enthusiastic employees. In addition, the fact that company contributions are contingent on the existence of a profit, profit sharing is generally less risky than outright bonuses.

The Cons of Profit Sharing

Some of the main strengths of profit sharing actually contribute to its potential weaknesses. While employees benefit from their profit sharing money, the assurance of its payment can make them appreciate less as a motivational tool and more as an annual entitlement. Since they receive their profit sharing contribution regardless of their job performance, individual employees see little need to improve. 

Unlike director-level employees who make decisions that can directly affect revenue, lower-level, and front line employees tend to be less aware of how their daily interactions with customers and the public can help—or harm—the company’s profitability.

  • Streissguth, Tom. " Do I Claim Profit Sharing Payouts as Income on Federal Taxes? " The Nest.
  • " Profit Sharing Plans for Small Businesses ." US Department of Labor.
  • Kenton, Will (2018). "Deferred Profit Sharing Plan (DPSP)." Investopedia 
  • Finch, Carol (2017). "Profit-Sharing Pros and Cons." BizFluent
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Definition of 'profit-sharing'

  • profit-sharing

profit-sharing in British English

Profit sharing in american english, examples of 'profit-sharing' in a sentence profit-sharing, trends of profit-sharing.

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In other languages profit-sharing

  • American English : profit-sharing / ˈprɑfɪtˌʃɛrɪŋ /
  • Brazilian Portuguese : participação nos lucros
  • Chinese : 分红制
  • European Spanish : reparto de beneficios
  • French : intéressement aux bénéfices
  • German : Gewinnbeteiligung
  • Italian : compartecipazione agli utili
  • Japanese : 利益分配制
  • Korean : 이익 분배
  • European Portuguese : participação nos lucros
  • Latin American Spanish : reparto de beneficios

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Age weighted profit sharing plan, employee profit sharing plan (epsp).

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  • profit sharing

the sharing of profits, as between employer and employee, especially in such a way that the employee receives, in addition to wages, a share in the profits of the business.

Origin of profit sharing

Other words from profit sharing.

  • prof·it·shar·ing, adjective

Words Nearby profit sharing

  • profiteering
  • profiterole
  • profit margin
  • profit motive
  • profit squeeze
  • profit taking
  • profit warning

Dictionary.com Unabridged Based on the Random House Unabridged Dictionary, © Random House, Inc. 2024

How to use profit sharing in a sentence

More generally, across the economy, non-production-based bonuses, such as profit sharing , amount to barely 2% of total compensation.

By doing so, he thinks he can garner better profit-sharing agreements with Hollywood movie studios and hence higher profitability.

One of these he was to hunt himself, the other one Ed Matheson had agreed to hunt on a profit-sharing basis.

In this latter sense the relation of the carrier to its clients partakes of a profit-sharing arrangement.

Co-operation and profit-sharing are not the only means by which this might be realized.

In France profit-sharing has made a much greater progress, and ordinary co-operation has met with slight success.

Strikes have almost ceased to exist in such institutions, and the future of profit-sharing is full of promise.

British Dictionary definitions for profit-sharing

a system in which a portion of the net profit of a business is distributed to its employees, usually in proportion to their wages or their length of service

Collins English Dictionary - Complete & Unabridged 2012 Digital Edition © William Collins Sons & Co. Ltd. 1979, 1986 © HarperCollins Publishers 1998, 2000, 2003, 2005, 2006, 2007, 2009, 2012

Cultural definitions for profit sharing

Distributing the profits, or part of the profits, of a business to its employees.

The New Dictionary of Cultural Literacy, Third Edition Copyright © 2005 by Houghton Mifflin Harcourt Publishing Company. Published by Houghton Mifflin Harcourt Publishing Company. All rights reserved.

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COMMENTS

  1. Profit-Sharing Plan: What It Is and How It Works, With Examples

    A profit-sharing plan is a retirement plan that gives employees a share in the profits of a company. Under this type of plan, also known as a deferred profit-sharing plan (DPSP), an...

  2. Profit sharing Definition & Meaning

    : a system or process under which employees receive a part of the profits of an industrial or commercial enterprise Examples of profit sharing in a Sentence

  3. What Is a Profit-Sharing Plan?

    Profit-sharing plans are a way for a company to share profits with its workers. Contributions are discretionary. The company can decide how much it will put into the plan from year to year. It can even decide not to contribute at all. This flexibility makes it a nice option for both small and larger businesses.

  4. Profit Sharing Plan Definition & Example

    Updated September 29, 2020 What is a Profit Sharing Plan? A profit sharing plan gives employees a share in the company's profits. How Does a Profit Sharing Plan Work? A profit sharing plan is usually structured to give a percentage of the profits to employees based on the company's earnings.

  5. PROFIT SHARING

    a system in which the people who work in a company are given part of the profits in addition to their regular pay (Definition of profit sharing from the Cambridge Academic Content Dictionary © Cambridge University Press) profit-sharing | Business English profit-sharing

  6. What Is Profit Sharing?

    Profit sharing is a type of pre-tax contribution plan for employees that gives workers a certain amount of a company's profits. The profit-sharing payments depend on the: With a profit-sharing plan (PSP), employees receive an amount based on the company's earnings over a specific period of time (e.g., a year).

  7. Profit-Sharing Plans: What Are They And How Do They Work?

    A profit-sharing plan is a retirement plan that allows an employer or company owner to share the profits in the business, up to 25 percent of the company's payroll, with the firm's employees ...

  8. PROFIT SHARING definition

    a system in which the people who work in a company are given part of the profits in addition to their regular pay (Definition of profit sharing from the Cambridge Academic Content Dictionary © Cambridge University Press) profit-sharing | Business English profit-sharing

  9. Profit sharing

    Profit sharing is various incentive plans introduced by businesses that provide direct or indirect payments to employees that depend on company's profitability in addition to employees' regular salary and bonuses. In publicly traded companies these plans typically amount to allocation of shares to employees.

  10. What is a profit sharing plan?

    Profit Sharing, Defined. Profit sharing; noun: A system in which the people who work for a company receive a direct share of the profits based on the company's annual or quarterly earnings. Profit sharing is a form of an incentivized compensation program for your employees. It increases loyalty and leads to raving fan employees because they ...

  11. What is profit sharing? Definition and examples

    Definition and examples. Profit Sharing involves giving employees a direct share of a company's profits. It is an incentive plan that companies pay in addition to their workers' salaries. The profit share may be in the form of money or stocks. In this context, the word stocks means shares.

  12. Profit Sharing Plan

    The profit sharing plan for small business is directed into a specific fund known as the trust fund, which provides the rewards to the employees at a later date, often on the employees' retirement. Accordingly, immediate taxation on the employees' incomes is avoided under a deferred plan. Further, the qualified investment plan provides ...

  13. Profit-Sharing Plan

    In business, the profit-sharing definition is a financial incentive companies use to share profits with employees depending on the profitability of the business. The employee may also...

  14. What Is Profit Sharing? Pros and Cons

    Profit sharing is a workplace compensation benefit that helps employees save for retirement by paying them a portion of the company's profits if any. In profit sharing, the company contributes a part of its profits into a pool of funds to be distributed among eligible employees. Profit sharing plans may be offered in lieu of or in addition to ...

  15. PROFIT-SHARING definition in American English

    [business] ...the bank's profit-sharing plan. Collins COBUILD Advanced Learner's Dictionary. Copyright © HarperCollins Publishers profit sharing in American English the practice of dividing a share of the profits of a business among employees, in addition to paying their regular wages and salaries

  16. PROFIT-SHARING definition and meaning

    noun the sharing of profits, as between employer and employee, esp. in such a way that the employee receives, in addition to wages, a share in the profits of the business Most material © 2005, 1997, 1991 by Penguin Random House LLC. Modified entries © 2019 by Penguin Random House LLC and HarperCollins Publishers Ltd Derived forms profitsharing

  17. Employer Profit-Sharing Plans: Definition and Benefits

    A profit-sharing plan is an innovative benefit that gives employees a portion of company profits. Depending on the specific type of plan, corporate profit-sharing plans can help employees increase earnings each year or save for retirement. When considering a position that offers this type of benefit, it's important to understand the specific ...

  18. What is profit sharing plan? definition and meaning

    Definition of profit sharing plan: Employee motivation plan (established and maintained by an employer) under which employees receive a share of the firm's profits determined by an agreed upon formula. See also stock bonus plan.

  19. profit sharing Definition, Meaning & Usage

    Definition of "profit sharing" A scheme where workers receive a portion of a business's earnings ; How to use "profit sharing" in a sentence. The company has a generous profit sharing plan that benefits all employees. Through profit sharing, workers can get an additional income based on the business's earnings.

  20. Profit-sharing plan

    Profit-sharing plan synonyms, Profit-sharing plan pronunciation, Profit-sharing plan translation, English dictionary definition of Profit-sharing plan. n. A system by which employees receive a share of the profits of a business enterprise.

  21. PROFIT SHARING Definition & Usage Examples

    Profit sharing definition: . See examples of PROFIT SHARING used in a sentence.

  22. PROFIT SHARING Definition & Usage Examples

    Profit sharing definition: . See examples of PROFIT SHARING used in a sentence.

  23. Profit sharing plan

    Profit sharing plan - definition of Profit sharing plan by The Free Dictionary profit sharing (redirected from Profit sharing plan) Also found in: Thesaurus, Financial, Acronyms, Encyclopedia. Deferred Profit Sharing Plan profit sharing n. A system by which employees receive a share of the profits of a business enterprise.