Profit-Sharing 101


If you’re thinking about offering a profit-sharing plan at your childcare business, then you will want to check out the following guide.

We cover everything you need to know about the basics of profit-sharing, including what a profit-sharing plan is and how it differs from a 401(k) plan, how profit-sharing benefits employers and employees, and what types of profit-sharing plans are used, as well as how the benefits are shared with employees. Let’s dive in!

What is a profit-sharing plan?

A profit-sharing plan is a retirement plan in which you, the employer, give your employees a share of the profits of your business. Profit-sharing plans are also known as deferred profit-sharing plans (DPSP), and they are an excellent way for you to give your employees a sense of ownership in your childcare company. Profit-sharing plans aren’t the same as 401(k) plans, so let’s take a look at some of the differences between them next.

Profit-Sharing plan vs. 401(k) plan

Profit-sharing plans and 401(k) plans have their differences. Here are a few of them:

  • In a profit-sharing plan, only the employer makes contributions on the employee’s behalf. In a 401(k) plan, an employee makes contributions of his or her own, which the employer can partially match, if desired.
  • Profit-sharing plans are not regulated by the Employee Retirement Income Security Act of 1974 (ERISA), but 401(k) plans are. The IRS has rules and regulations for profit-sharing plans to ensure employer contributions are fair and non-discriminatory among employees.
  • Employees must begin taking distributions from their 401(k) plans by April of the year they turn 73 years old, but they do not have to do so for profit-sharing plans.
  • If an employee leaves a job, he or she can take 401(k) money with them but cannot take money contributed to a profit-sharing plan.
  • In general, profit-sharing plans are less common than 401(k) plans.

Profit-sharing plans may work somewhat differently than 401(k) plans, but they offer significant benefits for both employers and employees, which we will cover next.

Profit-Sharing benefits for employers

Offering a profit-sharing plan to your childcare business employees gives you the following advantages:

  • ✅ Helps you attract and retain top talent for your company
  • ✅ Serves to motivate your employees and reward them for their hard work
  • ✅ Employer contributions to a profit-sharing plan are tax-deductible for you
  • ✅ Offers a customizable plan to meet your needs and those of your employees
  • ✅ Gives you flexibility in deciding whether and how much to contribute on an annual basis

Profit-Sharing benefits for employees

Similarly, a profit-sharing plan provides distinctive benefits to your employees as well:

  • ✅ Employees do not make their own contributions to a profit-sharing plan
  • ✅ Enjoy tax-deferred growth of employer contributions
  • ✅ Establish retirement savings instead of or in addition to a traditional 401(k) plan
  • ✅ Incentive to remain with your company
  • ✅ Motivation to work hard for the success of your company, knowing they have a stake in the profits

Now that we’ve covered some of the benefits of profit-sharing for you and your employees, let’s explore the different types of profit-sharing plans.

Types of profit-sharing plans

When it comes to profit-sharing plans for your Early Childhood Education company, you have four different options from which to choose:

  1. Cash-based plan – With a cash plan, the employer makes direct cash payments to the employee on a quarterly or annual basis. Cash payments are considered regular income and are therefore taxable.
  2. Deferred plan – With a deferred plan, the employer contributes to an employee’s retirement account. The employee can only access the funds when he or she retires or leaves the company.
  3. Combination plan – A combination plan is a hybrid between a cash plan and a deferred plan. The employer may make some cash payments directly and may also contribute to an employees retirement account.
  4. Employee Stock Ownership Plan (ESOP) – In this type of plan, employers give employees shares of stock instead of cash.

Finally, we’ll take a brief look at how profit-sharing benefits are given out to employees.

How profit-sharing benefits are shared with employees

Here are a few different ways you can share these benefits with your employees:

  • Pro-rata plan – With a pro-rata plan, benefits are shared among your employees based on how much each individual earns. Higher-earning employees will receive a greater percentage of the profits than employees who earn less.
  • Fixed-percentage plan – With a fixed-percentage plan, all employees receive the same percentage of the profits, regardless of how much they earn.
  • Age-weight plan – Age-weight plans give employees a larger percentage of the profit share based on their age or seniority within the company.
  • New comparability plan – With new comparability plans, employers use a variety of factors, such as age, length of time with the company, and more when distributing profit shares to employees

Ultimately, a profit-sharing plan can provide you with the flexibility and customization you need to create an attractive retirement savings plan that works for everyone at your childcare company.

Because you have a number of options when it comes to setting up your profit-sharing plan, we recommend working with a qualified financial advisor to design a plan that works best for your business. You will also want to know about the rules and requirements that apply to your company’s profit-sharing plan.

The accounting experts at Honest Buck can offer professional insight and help you determine which financial strategies are right for you. Get in touch with our team of accountants to get started. Contact us today.

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