Profit Sharing Plan
What it is:
A profit sharing plan gives employees a share in the company's profits.
How it works (Example):
A profit sharing plan is usually structured to give a percentage of the profits to employees based on the company's earnings. Profit sharing plans are usually incentive plans that provide a distribution of a portion of profits or, for publicly traded companies, a distribution of shares of stock in the company based on the performance of the company.
A profit sharing plan may be structured as a conditional contribution by the employer into an employee's retirement account, usually a 401(k) retirement account, in order to defer tax liabilities from the profit sharing contribution. For the most part, only employers may make contributions to the profit sharing plan, contributions into the plan are discretionary on the part of the company, employee participation is involuntary, and contributions are not subject to Social Security and Medicare taxes.
Why it Matters:
Profit sharing plans provide an important incentive for employee performance in the outcome (i.e. profitability) of a company. They give a stake in the company to the employees, allowing them to benefit from the upside of good company (and employee) performance. From an investment perspective, profit sharing plans are evidence of a partnership between management and employees in the success of the business.