An employer-funded retirement plan is often used as a tool to attract and keep good-quality employees. Both profit-sharing and individual retirement accounts are methods employers can use to provide for the future security of their employees as well as creating an incentive to stay with the company. Although some plans match a certain percentage of an employee’s contribution to his retirement fund, neither the SEP-IRA nor the profit-sharing plans allow employees to add funds to their accounts.
Profit-Sharing Plan Basics
A profit-sharing plan is a type of retirement plan that allows an employer to make contributions to an employee retirement fund. The employer decides on an amount to be contributed to the eligible employees as a group and makes that money available for distribution. The funds are then placed into individual retirement accounts for each employee, based on each person’s salary. Profit-sharing is flexible, since there is not a minimum contribution required for the employer, no requirement that profits must actually have occurred for a contribution to be made and no requirement that money be added every year.
A simplified employee pension individual retirement account, known as a SEP-IRA, is an employee retirement plan that depends exclusively on employer funding. All eligible employees must be provided with individual SEP-IRA accounts, and money must be placed into them equally. Once a contribution is made to a SEP-IRA, it belongs to the employee immediately, but if she takes it out of her account it will be taxed as income for the year in which it was removed from the IRA.
Form 5305 Restrictions
IRS Form 5305 is a quick, simple way to establish a SEP-IRA plan. The form must be filled out and a copy provided to each employee, but it does not need to be filed with the IRS. The form contains information for employees such as plan eligibility requirements, rules for participation, financial institution requirements and withdrawal information. There is also employer information including contribution limits, when Form 5305 can and cannot be used and which employees do not have to be covered under the plan.
Since a SEP-IRA and a profit-sharing plan are two distinct types of plans, it is not possible to combine them into a single employee retirement plan. However, an employer can operate both types of plans if he so chooses, provided the SEP-IRA is not set up using a Form 5305. A simpler solution is to add the funds that would be placed in a profit-sharing fund to the SEP-IRA fund instead, where the money will be distributed among all eligible employees. As with profit-sharing, there is no minimum amount nor any requirement to contribute to a SEP-IRA fund every year. It is important to seek the guidance of a tax professional when making decisions about establishing a retirement fund.