What Is a Profit Sharing Plan?

Profit sharing plans are types of defined contribution plans that have traditionally offered businesses more flexibility, but lower contribution limits, than money purchase or other retirement plans. In a profit sharing plan, the employer determines each year whether or not to make a contribution and how much to contribute to the plan. However, contributions must be "substantial and recurring."

As in a money purchase plan, the value of an employee's profit sharing account is the total of the contributions, earnings, and appreciation of the investments in the account. The compensation limit on employer contributions is 25 percent. The maximum annual employer contribution is $46,000 in 2008 (up from $45,000 in 2007).

Each plan must have a definite formula for how employer contributions are allocated to plan participants. The ways in which contributions are allocated can vary according to employee groups. For example, allocation can be weighted by employee age and/or length of service. However, the plan still cannot discriminate in favor of employees with higher salaries.

Benefits from profit sharing plans may be distributed in any form the employer chooses.

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