Profit-sharing plans: What to know

A profit-sharing plan is a type of retirement plan funded only by employer contributions. Employers choose how much and even whether to contribute based on quarterly or annual company earnings. 

What you’ll learn:

• A profit-sharing plan is one in which an employer makes contributions to their employees’ retirement funds based on company performance.

• Employers may contribute up to 25% of the company’s total payroll to a profit-sharing plan.

• For 2026, the contribution limit for an individual’s account is either 100% of the employee’s compensation or $72,000, whichever is less.

• Companies may change the amount they contribute from year to year, but they must have a set formula for how funds are divided.

Profit-sharing plans are retirement plans. They’re entirely employer-funded; employees don’t contribute. Contribution amounts can fluctuate and are usually connected to profits, but according to the IRS, a “business does not need profits to make contributions to a profit-sharing plan.”

Profit-sharing plans and 401(k)s are both employer-sponsored retirement accounts. Unlike a profit-sharing plan, a 401(k) plan lets employees and employers contribute. Employers can offer both profit-sharing plans and 401(k) plans.

Employers decide how much they want to contribute to a profit-sharing plan. That could be anything from nothing all the way up to the annual limit set by the IRS. The amount isn’t fixed, either, so they can change how much they contribute at their discretion. Contributions are usually made quarterly or annually, and the amount is normally influenced by company performance. 

Profit-sharing plans come with some rules and limitations for employers and employees alike. Companies must devise a formula for fairly dividing the total contribution among employees. Here are some other considerations:

Employers may use a vesting schedule to determine when an employee can access funds earmarked for them in the profit-sharing plan. This means the employee might only access the funds after working at the company for a set period.

Employees are able to begin making withdrawals from the retirement account of a profit-sharing plan after age 59 1/2. If an employee withdraws funds before that age, they can be subject to a 10% penalty on the amount they withdraw.

The IRS sets contribution limits. According to the agency, employers can contribute up to 25% of the company’s total payroll to a profit-sharing plan. There’s also a limit on how much each employee can receive. For 2026, contributions can’t exceed 100% of an employee’s compensation or $72,000, whichever is lower.

If an employer offers a profit-sharing plan, it’s often available for most employees. But the IRS lists the following conditions that may prevent an employee from being eligible:

• Being under 21

• Working for the company for less than a year

• Participating in a collective bargaining agreement, like a union

• Having nonresident alien status

The SECURE 2.0 Act of 2022 may also affect eligibility if the profit-sharing plan is tied to another retirement plan.

Aside from needing a formula for the fair division of contributions among employees, IRS guidelines give employers the freedom to make profit-sharing plans “as simple or as complex” as they want.

Common types of profit-sharing plans include:

• Comp-to-comp plan: The employer divides an employee’s compensation by the company’s total compensation to find the employee’s percentage. Then, the employer can apply that percentage to the total profit-sharing contribution to get the employee’s amount.

• Pro rata plan: The employer contributes the same amount to each employee, either as a fixed amount or a percentage of profits.

• Age-weighted plan: Employers can choose to give a larger percentage of a contribution to employees who are older. This provides older employees with more funds as they approach retirement.

• New comparability plan: An employer may set different rates for how it contributes to groups of employees. For example, there might be a higher contribution rate for company leaders. But even with this type of plan, there must be enough contributions for all employees to satisfy nondiscrimination rules.

Here are some advantages and disadvantages of profit-sharing plans:

• Free, tax-deferred savings: Profit-sharing comes with zero out-of-pocket costs for the employee. Plus, employees can add to their retirement savings without increasing their taxable income. 

• Ownership: Profit sharing can motivate employees and give them a sense of ownership in the company’s success.

• Portability: Employees who leave the company may be able to take their vested profit-sharing contributions with them.

• Unpredictability: There’s no guarantee an employer will contribute every period, regardless of the employee’s performance. Even if they do, the contribution amount isn’t fixed. This can make it more difficult for employees to plan ahead financially.

• Delayed ownership: Depending on the profit-sharing plan’s vesting schedule, termination of employment could result in full or partial loss of contributed funds. 

Profit-sharing plans are employer-funded retirement savings plans. The funds may go into an employee’s stand-alone retirement account or be added as a bonus contribution to a 401(k) plan. While employers aren’t required to contribute to a profit-sharing plan every year, they have to follow a nondiscriminatory formula that benefits all employees if they do. 

To learn more about retirement planning, check out this guide on how to save for retirement.