Rhode Island Life Insurance Practice Exam

A retirement plan that sets aside part of the company's net income for distributions to qualified employees is called a:

1. Pension plan

2. Profit-sharing plan

3. Defined benefit plan

4. Deferred compensation plan

The correct answer is: Profit-sharing plan

A profit-sharing plan is designed to allocate a portion of the company's profits to employees, thereby directly linking employee compensation to the company's performance. This type of retirement plan allows employers discretion in how much they contribute each year, which can vary depending on the company's profitability. The contributions are typically based on a predetermined formula, which may consider the employee's salary or years of service, among other factors. This plan is advantageous as it incentivizes employees to perform well, knowing that their efforts can lead to greater company profits and larger contributions to their retirement funds. In contrast, other options like a pension plan or defined benefit plan involve specified benefits that do not depend on company profitability; instead, they provide a fixed payout based on a formula involving salary and tenure. A deferred compensation plan allows employees to postpone receiving a portion of their income, but it does not involve the company's profits in the way a profit-sharing plan does. Your understanding of how profit-sharing works encapsulates the essence of why this answer is the most fitting choice.