A profit sharing plan is one in which contributions are determined at the employer’s discretion. Allocations can be based on a formula, a fixed dollar amount or percentage of compensation, integrated with social security or allocated to defined groups or employees.
The profit sharing plan is one of the most flexible qualified plans available. Company contributions to a profit sharing plan are usually made on a discretionary basis. Each year the employer decides the amount, if any, to be contributed which cannot exceed 25% of the total compensation of all eligible employees. The contribution is usually allocated to employees in proportion to compensation and may be integrated with Social Security which results in larger contributions for higher paid employees.
In profitable years, the employer may choose to contribute the maximum permissible. In lean years, they may opt for a lessor amount or no contribution at all. Flexibility is the main advantage of this plan type to many employers.
Age-Weighted Profit Sharing Plans: Profit sharing plans may also use an age-weighted allocation formula that takes into account each employee’s age and compensation. This formula results in a significantly larger allocation of the contribution to employees who are closer to retirement age. Age-weighted profit sharing plans combine the flexibility of a profit sharing plan with the ability of a pension plan to skew benefits in favor of older employees.