Under a profit-sharing retirement plan, employers can choose each year how much — if anything — they will contribute to their employees’ separate accounts, which are tax-deferred.
Once a contribution amount is declared, employers must follow whatever set formula is spelled out in their plan for distributing it. Distributions commonly are weighted so that employees with higher pay get more.
Care is in order, though. Profit-sharing plans are subject to top-heavy testing rules that allow the Internal Revenue Service to punish plans that grant too much participation to the highest-paid owners and employees.
Profit-sharing plans were once commonly combined with money purchase plans, which gave companies the benefit of high contribution limits and a degree of flexibility in determining the amount of each year’s contributions. In recent years, though, contribution limits have risen significantly for much simpler types of plans, removing most of the advantage from the money plan/profit-sharing combination.