How Does Profit Sharing Work?


Quick Answer

In most profit sharing programs, companies take a percentage of the annual profits, distribute them to a pool and allocating them to employees who are part of the program. Employers can decide how much to allocate to each individual employee and how they want to structure the payments. Some programs distribute funds as pay bonuses or open accounts that allow employees to collect returns on the funds.

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Full Answer

Pay bonuses can be a motivating factor, as most employees appreciate the boost to their paychecks and they can help employees feel like they are sharing in the company's success. However, profit sharing is often fairly abstract and hard to tie to individual performance, which can sometimes make employees complacent. Employers who want to use compensation as a purely motivational factor may want to explore other options such as performance-related bonuses.

Employers can also structure profit sharing funds into accounts for their employees. These programs tend to serve more as benefits rather than bonuses. They can help employees save for retirement, and the money is usually not taxed until it is distributed to employees. In this kind of program, employers can invest funds in stocks, bonds, mutual funds and other investment vehicles to gain a return on the original amount. This lets employees increase the funds in their accounts over time. They can withdraw the funds from their accounts when they retire. Many companies also let employees withdraw the money from their accounts when they leave the company.

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