Deferred profit sharing plans are the same as cash incentive plans, with the difference being instead of the employee getting the money when due, the money goes to an individual account and realizes to the employee only on death, disability, retirement, or on separation from the company, subject to conditions. The money accumulates and earns interest in the account.
The earliest instance of deferred profit sharing plans was by Harris Trust and Savings Bank of Chicago in 1916. World War II saw a freeze in wages. This led to a spurt of interest in deferred profit sharing, for it provided employers with a way to compensate employees without increasing wages.
The most popular sample profit sharing agreement with the deferred option bases itself on the 401(k) plan that allows employees to defer a portion of their salary to the plan, and thereby, save tax on such deferrals. Some 401(k) plans also have an employer contribution. Disbursing the amount before the employee retires, becomes disabled, dies, or reach 59 ½ years attracts penalty that offsets the tax saving advantage.
Like direct stock options, companies may also offer deferred stock options, with employees becoming eligible for shares of the company later, upon meeting certain conditions.
The biggest advantage of deferred plans is its tax-free nature. It also makes an effective and less hassle-free alternative to pension plans. Employees save on income tax and employers can write off employer contributions to a profit-sharing plan as business expense. The deferred nature of profit sharing also means companies gain employee loyalty and commitment over an extended period.
The disadvantage of deferred profit sharing plans for the employee is the very nature of deferred payment, which may make realization uncertain if the company goes back on its word, or if the employee leaves in acrimonious circumstances. Companies now entrust the management of deferred plans to third party agents, who can defraud or indulge in manipulations with the amount. From the company’s perspective, deferred profit sharing plans means spending time and resources in complying with the fiduciary duties associated with the scheme, and making provisions to honor the liabilities that accrue.
Many employers allow the employee an option between cash plans or deferred plans, or offer a combination plan that includes both options.