How to Set Up a Profit Sharing Plan

Cody Cromwell
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What Is Profit Sharing?

A profit sharing plan doesn’t just allow you to share a lot of money, it allows you to share in the success of your business. Profit sharing, according to the IRS, is a group of employees who share in the company’s profits.

This means the employees are entitled to a set amount of money each year that is allocated by the company, not by the employees.

The employee participation is usually required to be a certain percentage ranging from 2% to 10% of company profit.

What is a Profit Sharing Plan?

A Profit Sharing Plan is a retirement plan where team members are entitled to share in the company’s profits. Below are some suggestions on how to set up a profit sharing plan.

{1}. Consulting with an accountant is a necessity when setting up your Profit Sharing Plan.
{2}. Consult your human resources department to learn more about how many employees you should expect to participate, the eligibility criteria, and the amount of money to be allocated for the plan.
{3}. Remember that the numbers you plan to share by dividing profits between team members play an important role in the plan’s success. You could have a plan in place, but if it is poorly executed, it could just be generating losses. Thus, numbers are important.
{4}. It’s a good idea to discuss the plan with members of your team to ensure that they understand how they fit into the plan…and that they are happy with it.
{5}. Once the plan is established, develop procedures and forms that can be used to conduct the plan’s administrative work.

Two Main Kinds of Profit Sharing

There are two main types of profit sharing plans:

Defined Contribution Profit Sharing (DCPS) – This is the most common type of profit sharing plan, often employed by small businesses and medium sized enterprises. To better understand it, think of a DCPS as an employee benefit or an employee stock ownership plan (ESOP) for businesses.

Defined Benefit Profit Sharing (DBPS) – Unlike a DCPS, DBPS execute like a pension plan. It is often found in larger businesses as a retirement plan.

Together, they make use of a single governing document, called a plan document, for the purpose of explaining how DCPS or DBPS work and how the funds are going to be invested for future distributions.

Regardless of how big or small your business may be, a good profit sharing plan can provide your employees with a significant tax reduction, less human resource turnover and happier employees in return.

Gainsharing

Is a great way to motivate, encourage and reward.

Behavior

Gainsharing is a profit sharing technique that offers an incentive to employees for working together while maintaining a high level of customer services. It is a direct incentive that management implements that allows for employees to achieve a positive result on their performance.

The direct incentive benefits of gainsharing are the goal based conferences that are held throughout the year. Each team member is responsible for meeting their sales goal and communicates their plans to the team on a regular basis. This gives everyone a chance to be accountable and keep motivated about the sales goals

Gainsharing also brings company profitability up as a result of the increased sales and the ability of companies to keep up with their competitor’s budgets. This is the result of highly motivated team members who are dedicated towards providing great customer services and policies.

These types of communication are made available to management for review. Once the annual goals have met and the team’s results have been reviewed, management will then hold team performance conferences.

How to Set Up a Profit Sharing Plan for Your Small Business

Most employee-owned companies and high-tech companies often have Wellness Initiative Committees that, alongside other incentive plans, encourage employees to focus on their own health and well-being. Providing incentives for an employee’s own health and wellness can improve both their attitude toward their work-out and weight loss programs and their performance in their job. A profit sharing plan is an excellent opportunity to create a wellness committee and offer some incentives.

Self-improvement programs are nothing new, but they can have a positive effect on employee behavior and performance. For a profit sharing plan to be successful, three things are needed: The company first and foremost must have a Profit Sharing Plan. A Profit Sharing Plan is a plan that rewards associates for themselves and their efforts. Some companies have profit sharing plans that a director can activate at any time and some companies have a mandatory profit sharing plan part of the company’s bylaws. Your company must have a Profit Sharing Plan in place to begin this process.

The third thing is you’ll need a group of people to establish the program. You cannot depend on the employee’s willingness. To motivate each data there must be a method that entices them to engage in the program because they are doing this for their own good. And for them, profit sharing plans are a great incentive.

How to Set Up Retirement Plan Profit Sharing

How to Set Up Profit Sharing as Base Compensation

Profit sharing can be an effective manner of distributing profits among the stockholders. The shares of the corporation are divided into smaller shares that are called profit shares. The owner or the employee will be entitled to each share to be issued as they are proportionate to his or her ownership or employment.

There are different methods of forming a profit sharing plan. One of the common ways is by contract, that means the employer specifies an amount of shares that the employee will be granted at some future date. A profit sharing plan can also be structured by a contract but in this situation, the employee is given the share by contributing to the plan. In this case, the employee can start receiving the income during the course of employment or months later. Another way is by stock option, for you to know how this is done, read what else is a stock option.

These two methods make choosing an amount of shares and the dates for the plan and the payout easy for the employer. The employee can still prefers a 15,000 or a 20,000 profit sharing plan and will still get rewarded. But, the employer does not have to perform this calculations. Therefore, to set up a profit sharing plan, method to get paid is essential.

Benefits of Having a Profit Sharing Plan

Profit sharing plans are an effective means of motivating employees to increase profits and reach targets in a consistent manner. Also, by having a profit sharing plan, you can ensure that your employees are motivated and engaged in the goal of increasing the profitability of the organization. Profit sharing plans encourage employees to work together and take pride in seeing the group’s profits increase.

Administered profit sharing plans set out guidelines for how the profits are distributed out between members. The amount you allocate is directly tied to how profitable your organization has been.

Earned or discretionary profit sharing plans are based on the same principles as the earned or performance with the difference being that participation is voluntary.

A profit sharing plan structure generally consists of three main components:

  • a plan document or articles of association that presents the details of your profit sharing plan
  • a set of policies and procedures related to the administration of your profit sharing plan
  • the actual entity established to represent your profit sharing plan, which is generally called the … profit sharing plan trust…

In this post, we’ll take a look at how to set up a profit sharing plan that ensures your employees are motivated and engaged to reach the set objectives.

Risks of Profit Sharing Plans

A profit sharing plan is a cash bonus plan that companies may offer to their employees. The company will allocate a certain amount of cash and allocate a portion of this amount to each employee. The remaining amount will be kept by the company to be used for the future. Although there are no regulations on how much people should receive, there are certain common rules that apply to similar types of bonus plans.

Here’s a brief overview of how a profit sharing plan works:

Employees will receive a certain amount of cash (either a lump sum or in quarterly payments) within a certain period of time. For example, a year.

When the employees receive their payment, it will depend on what the employer prefers as to how it will be handled. In some cases they will be handled as individual accounts, in other cases it may be handled as a group account.

The remaining balance (money that the company has saved) will be used to stockpile additional funds for the future.

If employees pay into the profit sharing plan via deductions from their paychecks, then this will be considered as part of their gross pay.

Here’s a look at what the plan may look like:

What Other Small Businesses Are Doing

Additional income for your employees is a like a wish come true as a business owner. Creating a profit sharing plan is a way for you and your employees to benefit equally.

If you do not want to share all of your profits with your employees, you can offer profit sharing plans. For some, they may seem complicated but they are actually easy to set up and this post will give you all of the information you need to get it done.

Alternative Incentives to Profit Sharing

A profit sharing plan is an arrangement in which one person or people are granted certain percentage of the profit generated by everyone who works for an organization. When a profit is generated, this person or people are granted a percentage of the profit.

The percentage of the profit given to the profit sharing person or persons usually varies depending on the profit he or she is having generated (in percentage terms). This percentage of profit can be decided by the organization members themselves and often varies per person depending on the contributions involved in generating the profit.

Individuals who benefit from profit sharing have a huge incentive to be involved in management of the organization because the chances of them getting profit sharing is directly proportional to their participation in the organization, or at least their contribution to the profitability of the organization.

Individuals who benefit from profit sharing usually get to share in some other non-financial benefits as well, such as advertisement when the organization’s name is mentioned in the media, increased chances to be associated (at least implicitly) with the organization, an opportunity to increase their visibility in the eyes of the people they manage, and other social benefits.

Since profit sharing gives one individual or group of individuals a great incentive to be actively involved in the functioning of the organization, it is common for a profit sharing plan to be rolled out by an organization to motivate the individuals who serve the organization to provide quality services or products.

Idea 1: Monetary Bonuses based on Company Goals

Idea 2: Monetary Bonuses based on Individual Goals

It’s important to figure out how the profit sharing works before deciding how many shares each employee gets. Because profit sharing happens after tax, the amount available to reward for team performance is generally less than the amount of shares given based on individual performance because not all shares are taxed.

For example, Company A starts with going with the common approach of quarter-based profit sharing. Each quarter, one share is earned for each quarter in which one’s company achieves its goals. The goals are usually based on its business direction or the strategic goals it has set for the year.

Company A holds a team meeting with all its management to discuss the profit sharing formula. Based on the meeting’s final decision, each management staff member gets 0.75 shares for each quarter in which his or her performance is above-average, and 0.25 share for each quarter in which he or she performs below-average.

Following this, each management staff member is paid based on the number of shares he or she has.

Company A can also consider individual goals for its management staff before setting up the profit sharing share amount based on a team meeting or by conducting a performance review. It’s also possible to determine an individual’s profit below-average by calculating the percentage of a staff member’s goal that he or she has missed.

Idea 3: Traditional Performance Management

Great teamwork is necessary to achieve solid results. This is why many companies have a profit sharing plan in their compensation package. As far as pay that emphasizes teamwork, this subject is the most obvious one to exclude from the pay conversation. Unfortunately, in the absence of performance management, there is usually no way to link team performance to a participant’s individual contribution.

While profit sharing plans can lead to higher wages, they cannot encourage or reward a company team to perform better. Performance management is an important tool for developing this kind of link.

The second-leading reason for the failure of profit sharing plans is that the result is often to have more autonomy, but less responsibility. The "right" performance management and profit sharing plan for your company should encourage your team members to establish better performance standards, rather than reduce individual accountability. It gives recognition when they go beyond those standards.

The third possible reason for the failure of profit sharing plans is they often focus only on the individual and not on the team.

In order to determine the best profit sharing plan for your team, speak with the leadership team about employee feedback and performance objectives for the year. In addition, make an evaluation of how well the profit sharing plan emphasizes the team, even during times of organizational change or in the absence of management.

Idea 4: Fringe Benefits

Let’s say you have a commercial washroom, and you need to decide what products to stock and how much to charge. Your best bet is to do a careful analysis of your potential clientele.

If you host office staff and healthcare workers on a regular basis, you might want to stock products that will make their days easier. Perhaps you could offer a line of shaving cream and shower gels, or maybe a baby changing station. In that case, you might need to invest in an electrical outlet or even a baby-changing table.

When you think about it, these are all basic amenities that have been overlooked in the past. Now, there are businesses that cater specifically to these needs.

Another idea might be to add some actual services to your washroom. You could install a coin-operated wall-mounted fax machine, payphone, photocopier, or computer. You’re installing these things in order to generate additional income, not fundamentally change the purpose of the washroom. They’re for the convenience of the guests in your washroom.

So how can you add this efficiency to your washroom?

The answer might be to offer corporate wellness services. The regular use of some of these products and services might help companies cut down on sick-days and related call-offs.

The Bottom Line

Profit Sharing Plan vs. 401k

Are you looking at setting up a Profit Sharing Plan? The Profit Sharing Plan can be a good option to secure your rights to earnings and benefits in the event you are laid off.

When considering a Profit Sharing plan you should talk to your Human Resource department to see what kind of plan is available and follow their guidance. In some cases (where you have the ability to make changes) you can elect to establish a Profit Sharing plan instead of a 401k. The key difference between the Profit Sharing plan and the 401k is that your contributions to the Profit Sharing are not tax deductible. The Profit Sharing Plan is very similar to a 401k except you must have a majority of the workers in your business to elect the Profit Sharing as well as have the plan document

If you elect to set up your Profit Sharing plan you have a better chance of the plan being accepted because you are making a financial commitment to the company. This requires adequate consideration by management and a determination of how an employee would react if he or she has no other opportunities should he or she be laid off.

If you are missing out on the Profit Sharing because you think it is too complicated, you should talk to your HR department. They will be able to guide you on how to set up and administer the plan.