04/ 30/ 2008
by Maggie Flynn
If you're looking for a way to give your employees a bigger stake in the company, fund their retirement plans or regulate year-end bonuses, a profit-sharing program might be the solution for you. Giving employees a larger chunk of your company's bottom line might sound risky, but it often gives employees a boost in motivation. Read on to discover the ins and outs of profit sharing.
How it works
Generally, there are two types of profit-sharing plans. The first consists of giving employees monthly or yearly bonuses. For example, let's say that your business adopts an end-of-year profit-sharing plan in which you'll split 15 percent of gross profits among employees at the end of the year. This would likely be given in the form of a check, much like a regular bonus check. You could also add a monthly profit-sharing bonus to employees' base salary, much like a sales commission. Whatever bonus employees receive will count toward their taxable income.
The second profit-sharing method for small businesses to adopt is a type of employee retirement plan, which you can set up through your bank. Basically, you decide upon a fixed yearly amount to contribute to your employees' account—and unlike other money purchasing plans, you have the option not to contribute if, for example, your business ends up in the red one year. In 2008, you may contribute up to 25 percent of an employees' total compensation, not exceeding $46,000. As an added bonus to your employees, they won't be taxed on the money until they withdraw it.
The benefits
As your employees are key contributors to your business, it's wise to reward them when profits are high. This makes employees feel appreciated and gives them an incentive to stick around. Profit sharing may even make them work harder. While your employees likely care about the health of your business, they'll care even more if it translates into bigger paychecks or savings. Small business owners often find that instituting profit-sharing plans leads to higher employee productivity and job satisfaction.
Profit-sharing plans are also fiscally attractive to you, the employer. Not only does profit sharing allow you to base bonuses on whether or not the money is there to give, it allows you flexibility when considering employee salary. For example, let's say that you've had the same office manager for 15 years and she has reached the upper tier of her salary range. A profit-sharing plan allows you to give her an incentive to stick around, even when you can no longer significantly raise her salary.
The drawbacks
Rewarding your employees as a team unarguably produces many positive results, but also some drawbacks. Imagine profit sharing as a restaurant that has servers pool their tips at the end of a shift and split the money equally. Consider the server who worked hard to provide customers with a great dining experience and averaged $20 on each table versus the indifferent server who only averaged $10. Is it truly fair that both of them will take home the same amount of money at the end of the night? Profit sharing risks rewarding the employees who are letting the rest of the team pick up their slack.
Also, profit sharing can be risky if you're making it your employees' sole retirement plan. Many employees will feel greater security with a traditional 401k that rewards them for their years with the company, regardless of its financial health. Employees that stick with a business during the lean times likely deserve a reward, not a shrinking retirement contribution. So unless your business is averaging more profitable years than not, a profit-sharing plan may not seem like a great incentive for your staff to stick around.
If you think a profit-sharing plan is right for you, talk to your accountant or the account manager at your bank. They will help you choose a plan the fits your budget and set up employee eligibility. As an added bonus, your contributions to profit-sharing retirement plans are tax deductible, so you'll not only be rewarding your employees but yourself as well.
