Sorting through the multitude of retirement plan options

Rough Notes, Oct 1999 by Clemmer, William A, Lesser, Gary S

For those who are concerned about their long-term welfare-whether it be for themselves as individuals or for their employees and their businesses-the basic decision to take advantage of the many benefits offered by a retirement plan is a relatively easy one. Nevertheless, let's review the basic reasons for a retirement plan.

Tax-deferred assets grow faster than assets on which taxes have been paid. This is true simply because there is more money to grow-$100,000 will grow faster than $60,000.

The growth on the unpaid tax in a tax-deferred account will accrue to the plan's trust and owners of the accounts in some types of retirement plans. This has a compounding effect on the asset and in a 401(k) plan gives the owner the use of the tax-funds for a period of time.

Taxes on the account, which become due when distributed, are likely to be lower and can be spread out over the recipient's lifespan (and in some cases extend into that of a surviving spouse). This provides for tax planning. A special forward averaging tax may be used in the case of older participants who participated prior to 1975. So taxes may be reduced on current income, may be planned for in the future and may be lower in the long run as well.

The retirement plan has become a recruiting tool due to increasing competition for good employees.

The bottom line is the possibility of both money for retirement and more money in retirement.

The harder decision

The far more difficult decision to make is which plan to choose: qualified or non-qualified ... defined contribution or defined benefit ... profit-sharing or 401(k). Making this decision requires an understanding of the basic characteristics of each type of plan and how they relate to the situation of each participant. Even the timing of a contribution can be a factor.

A defined contribution plan, where the contribution is pre-determined and the results are a function of the underlying investment, is often most favorable if the following objective or conditions exist:

1. The participant is younger, or there are many younger employees, who have longer working lives ahead of them. This will allow them to accumulate a larger retirement asset base either from personal or employer contributions to the plan.

2. The plan is simple and easy to understand and administrative requirements and costs are kept to a minimum.

3. Employees with fewer years of service and those with longerterm employment are treated equally. Here the same percentage of compensation is allocated to all accounts although a plan may be designed to favor higher-paid employees and owners.

4. Employees who die before their retirement are assured that their beneficiaries will receive their account balance. Many defined benefit pension plans do not provide a pre-retirement death benefit.

A defined benefit plan would be advantageous when an employer wishes to attain the following objectives and recognize one or more of the following situations:

1. Older employees may receive a larger percentage of employer contributions since their retirement benefit must be funded over a shorter period of time than that of the younger employees.

2. Older employees are to receive credit for past years of service.

3. Employees who live until retirement age are normally due regular income guaranteed to last for their lifetime, or for that of the participant and the spouse, or for a specified period, such as 120 months.

4. The amount received by the employee at retirement is a definite amount based on a specific formula that does not depend on investment results, as is the case with a defined contribution plan.

Retirement plans are quite flexible and can be designed to meet a number of specific participant and employer objectives:

Tax deduction or reductions for individual participants and for all sizes of employers.

Choice of returns on investments vs. guaranteed returns on investments.

Employer costs can vary with options, investments and benefits.

Costs can be passed along to employees.

Benefits specifically for a single group of employees, such as highly compensated employees, longer-term employees or rank and file employees.

Flexibility of contributions.

Employee benefits that are specifically advantageous-such as to retain key personnel or to match benefits or features provided by competing firms.

Employees may be encouraged to save and participate in their own retirement program.

Other purposes such as to negotiate in labor-management accords.

Better administration of the plan and the retirement trust.

Ability to move assets out of the company into a trust specifically and legally for the benefit of the participating employees and their beneficiaries.

Desirability of making assets designed for retirement savings more difficult to get at before retirement.

Ability to guarantee benefits and payments for specific times and situations.

Yet there are specific requirements for plans in order to receive tax qualification and operate under the umbrella granted them by the regulations. This is where a retirement plan advisor can assist in making certain that the regulations are carefully followed. The penalty for non-compliance can be a loss of the tax deduction, tax liability, and other sanctions under ERISA and the Internal Revenue Code.