A profit-sharing plan is a defined contribution plan in which your employer has discretion to determine when and how much the company pays into the plan. The amount allocated to each individual account is usually based on the salary level of the participant (employee).
Your employer’s contributions to your account, and any investment earnings, accumulate on a tax-deferred basis–the IRS will tax these benefits as part of your regular income only when you begin receiving distributions from the plan, typically after you retire or terminate employment. Whether you can make withdrawals while you are still employed depends on the terms of your plan. For example, some plans permit withdrawals after you’ve attained at 59Â½, or after you’ve been a participant for some specified period of time (usually at least five years), or in the event of a financial hardship. (As an alternative to a taxable withdrawal, you may be able to borrow up to 50 percent of your vested account balance if your employer permits plan loans.)
Be aware that if you take distributions before age 59Â½, they are subject to a 10 percent penalty tax unless an exception applies. The penalty tax does not apply to distributions you receive after you terminate employment, if your separation occurs during or after the year you reach age 55. The penalty tax also does not apply in the case of distributions made due to a qualifying disability, distributions that qualify as substantially equal periodic payments, amounts you roll over to an IRA or another employer plan, distributions up to the amount of unreimbursed medical expenses, distributions made under a qualified domestic relations order (QDRO), or distributions after your death.
Each plan has a trustee who is generally responsible for managing the plan assets and for preparing various financial and tax documents. Other administrative duties are overseen by a plan administrator, who will frequently hire a third-party administrator to perform most administrative functions. Most plans contain a vesting schedule, often between three and six years, during which time an employee becomes fully vested in the plan. If you were to leave the company prior to full vesting and move your account elsewhere, you would forfeit all or a portion of the account’s accumulated value. Profit-sharing plans are usually funded using mutual funds, variable annuities, or life insurance. In certain cases, you may have the authority to direct the investment of the assets in your profit-sharing account. The summary plan description, available to each eligible participant, spells out the details of your plan.