Does your employer provide you with the option to sign up for a profit-sharing plan? If so, you may want to make the most of this opportunity to boost your retirement goals. However, what does this type of plan entail? And how can it help you take your retirement planning to another level? Let’s uncover every corner of this retirement savings option below.

What Is a Profit-Sharing Plan?

There are many key factors to consider when deciding whether this retirement plan is right for you. And it’s best to begin with the basics.

So what is a profit-sharing plan? It’s a retirement plan that gives an employee a share in company profits based on quarterly or annual earnings.

Many businesses in America offer this plan today. And it’s a great way to give employees a sense of ownership in the company they work for. But like most retirement benefits, there are specific withdrawal restrictions for the account holder. And according to the Internal Revenue Service (IRS), the employer can make the plan as simple or as complex as they want.

There are pros and cons for both the employer and the employee. And contributions are strictly discretionary.

How Do Profit-Sharing Plans Work?

A profit-sharing plan accepts discretionary employee contributions. This is unlike a traditional 401(k) plan, which offers personal contributions. In addition, the employer decides how much of the profits to allocate to each employee.

A company can also adjust its plan over time as needed. But for each year the company makes a contribution, it must determine a set formula for the profit allocation. This means that, in some years, the company may decide to make no contributions at all.

However, the most common profit allocation formula is the “comp-to-comp” method. This is when the employer calculates the sum of all of its employees’ compensation, known as “total comp.” Next, it divides each individual employee’s compensation by the “total comp.” The company will then multiply the resulting number by the total amount of the employer contribution.

This final figure gives you each employee’s share of the employer contribution. As you can see, your share of the employee contribution will come down to your annual salary.

Profit-Sharing Plan Rules and Requirements

Any business can offer a profit-sharing plan to employees along with other retirement benefits. The business also has full discretion over how and when it decides to make a contribution.

But the contribution limit for a profit-sharing company in 2021 is $58,000. This number rises to $64,500 when you include catch-up contributions for employees who are 50 or older during the year. Furthermore, all companies that offer this retirement plan must prove that the plan does not discriminate in favor of highly compensated employees.

There are also regulations in place for employees when it comes to withdrawals. In general, you will have to pay a penalty on any withdrawals from your profit-sharing plan before the age of 59 1/2. You also may be subject to vesting requirements.

If you want to withdraw from your plan before meeting the age requirement, you will be assessed a 10% penalty. However, you may be able to avoid this penalty if your company’s plan offers withdrawal exceptions. And as you now know, the company has full discretion over its plan.

Make Your Retirement a Priority

You can improve your retirement outlook no matter how far you’re behind. For the latest retirement strategies, sign up for the Wealthy Retirement e-letter below.

Your path to financial freedom in retirement is attainable through savings efforts and maximizing your benefits. Learn more about your company’s profit-sharing plan and determine if it’s right for you. Also, to see how your savings and investments can grow, consider trying out this free investment calculator.