What is a Profit Sharing Plan?

Published by Thomas Herold in Investments, Laws & Regulations, Retirement

'Profit Sharing Plan' is explained in detail and with examples in the Investments edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.

Profit Sharing Plans are not all the same. These plans can come in a range of different formats. Many times they are utilized as a supplement to another kind of retirement account. These defined contribution plans prove to be a significant benefit with tax advantages for a number of American employees.

The reason that employers establish these types of plans is to provide valuable employees with another method of compensation. This particular one permits the employees who participate to receive a portion of company earnings from a trustee. Individuals who have the benefit of a profit sharing account will enjoy contributions made by their employers to their personal plan account. They can then invest these funds and increase them tax free. Maximum individual employer contributions per year are limited to $53,000.

There is a caveat to many of the retirement plans that are employer sponsored. They typically require the employees to become vested in the plan over a period of pre-defined years in which they participate. It might be the employees gain 20% vesting per year over five years. While Money Purchase Plans set up a pre-arranged percentage of yearly earnings which become contributed to the accounts, profit sharing works differently. These plans and their contributions are based on the profitability of the company.

The rules that are typical of these defined contribution plans apply to profit sharing as well. Withdrawals can not be taken before the account owner reaches 59 ½ years of age. If they do take distributions earlier than this, the withdrawals will be fully taxed like personal income. They will also have the standard 10% early withdrawal penalty assessed against them.

The money from profit sharing plans is commonly invested by the trustee administrators into one of several investments. These include variable annuities, mutual funds, company stock, or life insurance. In rare cases with specific job scenarios, the individual employee may be allowed to manage the investment vehicles within the profit sharing account.

Rollovers have a specific set of rules that govern them with profit sharing accounts. The only money from these accounts that can be rolled over is that which has become fully vested. It is important to understand completely the schedule for vesting before account holders think about moving retirement funds to another qualified type of account. The IRS has no unusual restrictions on transferring vested profit sharing account funds. The plan administrator will have to mail out specifically detailed explanations to the account holder of how this can be done without incurring any taxes or penalties.

This is important because if the distribution is not properly rolled over, then the disbursed funds may be treated by the IRS as an early withdrawal. In this case, they will be taxed as ordinary income and suffer the 10% penalties for being taken out ahead of minimum retirement age. This is why transfers such as these should be done as direct rollovers in lieu of indirect rollovers whenever possible. Withholding requirements apply to indirect rollovers besides the danger of experiencing penalties for accidental early distribution.

Plan providers determine what specific investment choices an account owner may pursue with the money from their profit sharing plan. Much of the time, account holders do not have the ability to determine the investments that their profit sharing money participates in at all. The IRS allows investments for these funds that include individuals stocks, government and corporate bonds, mutual funds, options, and exchange traded funds shares.

While these choices may be available to a profit sharing plan account owner, investing in physical gold bullion and the other precious metals is not. Gold ETFs and gold mining company stock shares may be an alternative option for those who wish to diversify away from dollar based assets.

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The term 'Profit Sharing Plan' is included in the Investments edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.