A profit-sharing plan can help a business attract employees and motivate them to perform better by rewarding them with a share of the company’s earnings. Also called a deferred profit-sharing plan, a profit-sharing plan is a retirement plan in which the employer makes discretionary contributions but employees do not make any contributions. A business can change the amount it contributes each year and can forego a contribution if it would like. But if it does award employees a share of profits for a given year, the company’s contribution must be distributed among employees in accordance with the allocation method that it has established.
There are many ways to calculate profit sharing. Comp-to-comp is the simplest, as each person receives an allocation proportional to his or her pay,
The easiest profit sharing formula is the comp-to-comp method, which gives each employee a contribution that's proportionate to his or her pay. To calculate the employer contribution, add the compensation for all employees. Divide each employee’s compensation by the total to get their percentage of the overall compensation. Then give each employee an equivalent percentage of the profit-sharing bonus.
Pro-rata is another simple profit sharing formula as all you're doing is awarding every employee the same bonus in terms of percentage of their pay or a fixed dollar amount. So, if one employee gets a profit-sharing bonus equal to 10 percent of their compensation then all do. Or, everyone may get the same bonus of $1,000.
Uniform Points Allocation
Set point values for criteria like age and service. Then calculate the number of points that each employee has based on those criteria. If you award one point each for age and year of service, then a 40-year-old employee with 10 years of service would get 50 points. You would then pay employees based on their share of the total points. An employee with 5 percent of the points would get 5 percent of the company’s contribution to the profit-sharing plan, and so forth.
Integration Method, Also Called Permitted Disparity
If you want to give additional bonus funds to higher-income employees, you can base their distributions on an integration level. The integration level is a percentage of the taxable wage base for Social Security, which the federal government may adjust annually. You can then award a base percentage to all employees and pay additional bonuses for an excess percentage of the integration level. If the integration level is $130,000 for a year, then employees who earn more than that can receive an additional bonus up to the maximum disparity percentage allowed under federal guidelines.
Allocating the profit-sharing contribution based on age would allow you to give more to older employees. Fix an interest rate based on a mortality table that you include in your plan document. Then calculate an actuarial factor based how many years each employee has until they reach retirement age as defined in the plan document. Multiply their compensation by their actuarial factor to get their points. Then distribute bonuses according to each employee’s percentage of the total points. Older employees should get larger shares.
New Comparability Method
Classifying employees according to factors like title, job function or geographic location allows you to choose a contribution rate for each group. You could give a higher percentage of the contributions to certain groups, like senior executives, but you must pass nondiscrimination testing in accordance with federal guidelines to confirm that highly compensated employees are not overly compensated.