Info about Profit Sharing
Profit Sharing
Profit sharing, when used as a special term, is referring to a variety of incentive plans that are introduced by businesses that provide direct or indirect payments to employees that depend on company's profitability in addition to employees' regular salary and bonuses. In publicly traded companies these plans typically amount to allocation of shares to employees. Not all employers will offer profit sharing to their employees, but it seems to be more common among businesses offering other benefits such as 401K, life insurance and medical insurance plans. The profit sharing plans are based on predetermined economic sharing rules that define the split of gains between the company as a principal and the employee as an agent. For example, suppose the profits are x, which might be a random variable. Before knowing the profits, the principal and agent might agree on a sharing rule s(x). Here, the agent will receive s(x) and the principal will receive the residual gain x-s(x).
In the United States, a profit sharing plan may be set up where all or some of the employee’s profit sharing amount can be contributed to their current retirement plan. Profit sharing plans in the US are often used in combination with 401K retirement savings plans. Gainsharing is a program which returns cost savings back to the employees, most typically as a lump-sum bonus. This is a productivity measure that is different from a profit-sharing which is a profitability measure. The three main types of gainsharing including the Scanlon Plan (designed to lower labor costs without lowering the level of a firm’s activity), the Rucker Plan (uses committees; a ratio is calculated that expresses the value of production required for each dollar of the total wage bill, and Improshare (“Improved Productivity through sharing”, where a standard is developed that identified the expected number of hours to produce something, and any savings between this standard and actual production is shares between the company and the employees).
Profit sharing is often used in conjunction with other retirement plans for employees. Retirement plans are financial arrangements that are designed to replace employment income upon retirement. The plans are set up by employers, as well as trade unions, insurance companies, government and other institutions. In the United States, retirement plans are defined in tax terms by the IRS code and are regulated by the Department of Labor’s provisions under the Employee Retirement Income Security Act.
There are a variety of types of retirement plans available which can be used in combination with the profit sharing plan and 401K savings plan. Retirement plans are classified as defined benefit or defined contribution according to how benefits are determined. A defined benefit (or pension) plan calculates benefits using a fixed formula that typically factors in final pay and service with an employer, and payments are made from a trust fund specifically dedicated to the plan. In a defined contribution plan, the payout is dependent upon both the amount of money contributed into an individual account and the performance of the investment vehicles utilized. Some types of retirement plans, such as cash balance plans, combine features of both defined benefit and defined contribution schemes.