Profit-sharing plans can be an effective incentive tool to help employees focus their efforts on the long-term success of your startup. Profit-sharing plans reinforce the importance of the long-term success of the company, because the employee will see that their stake in the profit sharing depends on your startup’s ongoing success.
Essentially, there are two basic types of profit-sharing plans: a cash or bonus plan or a registered deferred plan.
Under a cash or bonus plan, employees receive their profit-sharing distribution in cash at the end of the year. The main disadvantage to a cash distribution plan is that these profit-sharing bonuses are then taxed as employee income. Even if distributions are made in the form of company stock, they are taxable upon receipt.
To avoid immediate taxation, companies are allowed by Canada Revenue Agency (CRA) to set up registered deferred profit-sharing plans. Under a deferred plan, profit-sharing distributions are held in individual accounts for each employee. Employees may only withdraw from their profit-sharing accounts under certain conditions such as termination or retirement.
Under registered deferred profit-sharing plans, employees may be given a range of investment choices for their accounts, including stocks or mutual funds. Such choices are common when the accounts are managed by outside investment firms.
|Type of profit-sharing plan||Advantages||Disadvantages|
|Cash or bonus plan||
|Registered deferred plan||
Companies may use different formulas to calculate the distribution of profits to their employees, and establish a variety of rules and regulations regarding eligibility. For example, allocation of profit can be:
When setting up a profit-sharing plan, consider the following:
For help in establishing and operating a profit-sharing plan, contact a retirement-plan professional or a representative of a financial institution that offers retirement plans.