Profit-sharing plans are a form of retirement plan where the employer shares their profits with their employees based on how much they earn. One of the most well-known types of profit sharing is the 401(k), which comes with capped contributions from the employer.
Tax deferrals are one of the most important reasons people opt for profit sharing. There are quite a few other advantages as well. However, like everything else, profit-sharing plans also have a flip side. An overview of the pros and cons will help you decide whether you should opt for it as a viable retirement plan, whether you are an employer or employee.
Pros of Profit-Sharing Plans
Here are some benefits of profit-sharing plans.
Flexibility
Small business owners and employers like profit-sharing plans because they give them the freedom to manage their cash flow based on their annual income. There are no mandatory contributions. The employer may make a considerable contribution one year and zero the next.
The capped contribution is 25% of the employee’s salary or $58,000, whichever is lower. The employer can choose a specific percentage of the annual profits and share it with all the employees or a group of employees, like the managers.
The company decides the distribution formula, which can include stocks, bonds, or just cash. The employees will have a guaranteed income from it and fall under the 401(k) plan.
Job Security
Suppose you work for an organization that offers you profit sharing as a part of a 401(k) plan. In that case, you are working for a secure company with a name in the industry. These companies do not just offer a part of the profits like that unless they know they can sustain it.
Even if contributions are not mandatory, the fact that they make enough to consider sharing a profit and securing their employees’ futures with it is worth some consideration. Despite being a small business, it is an excellent strategy to retain employees. It would be best if you desired to work for such progressive employers.
Greater Benefits Later
Although the company gives away a part of the profits to the employees, which is included in the budget, it saves more in the long run because it retains employees instead of hiring new ones.
They don’t have to spend on recruitment and training, which means better allocation of resources. This creates a snowball effect, and it will add to the company’s profits later. This will again increase employee profits in the long run.
Prevents Stagnation
The biggest obstacle to your professional development as an employee may be inaction and stagnation. When you are a part of a profit-sharing plan, the entire team becomes more motivated and accountable for their work.
They strive to perform better, and you will perform better as an employee. This will increase your efficiency, increase your profit percentage, and improve your chances in other segments.
For example, your better performance could result in an early promotion. This will be the case for everyone, which will bring in more profits for the organization, enabling the employer to give a higher profit percentage the following year.
Cons of Profit-Sharing Plans
However, there are certain downsides to profit-sharing plans as well.
Rewards Are Not Always Equal
The percentage of profit the employer chooses to share with the employees may not be equal for all. Higher-level managers may get a higher percentage. If you are a junior-level employee who feels they have worked equally hard, if not more, the system might seem unfair.
You must be sure you will not let the arrangement affect your work. In many cases, this creates dissent in the organization as employees are unwilling to work hard just to see someone else walk away with the fruits of their labor.
Unless everyone is on board with the arrangement, the company may suffer, and so will your share of profit.
Unpredictability
You might find it unpredictable because annual employer contributions to the profit-sharing plan are optional. You would not be able to rely solely on it for your retirement.
On the other hand, if your employer offers you profits in the shape of stock options, and if the stock prices fell, then you would be left with nothing. There is quite a bit of unpredictability surrounding profit-sharing plans, which needs to be managed very well to incentivize the employees.
Lower Income in Hand
Many employees opt for a profit-sharing plan just because their coworkers are signing up for it or because the employer wants to cover everyone. Many companies choose to see this as a perk and offer a lower salary in exchange.
However, if the profits are not as high as expected or if the employer chooses not to contribute to the plan in a specific year, then there is very little for the employee to gain that year. This might make the employee feel undervalued and even cheated, and you just have to put your faith in the company and keep on working.
Hence, profit-sharing plans can benefit the company and the employees if they are structured properly. If there is no accountability, and if it is left unsupervised, it will jeopardize the company, as well as the employee morale. Hence, having a clear idea of the pros and cons will help you understand what it entails.
At South Star Wealth Management, we can help you understand profit-sharing plans better. Whether you are an employer or an employee, our experts will tell you what profit-sharing means for you and how to make the most of it. We also help you choose the best retirement plans and investment strategies. If you fall under the 401(k) category, what will your retirement look like if your employer offers this plan to you? What other retirement plans can you opt for?
Contact us today, and our experts will tell you about our services and help you decide the best course of action for your future.