Evaluating whether to adopt a retirement plan.

• Author: Ellentuck, Albert B.
• Position: Case Study

Qualified retirement plans appeal to both employers and employees. In today's job market, such plans help employers compete with other firms that offer such plans. Employers find qualified retirement plans attractive because, like salaries, contributions to such plans are deductible. However, unlike salaries, contributions to a qualified retirement plan (other than employee elective salary deferrals) are not subject to Social Security and Medicare taxes (FICA taxes). This saves taxes for both the employee and the employer.

Advantages of Qualified Plans

A qualified retirement plan helps to attract suitable employees and retain existing employees. The use of a vesting schedule that requires an employee to complete a specified number of years of service before having a nonforfeitable right to employer contributions encourages employees to stay with an employer. Weighting the contribution or benefit using years of service may also serve to retain employees. Another advantage for both the employer and the employee is that funds accumulated in a qualified retirement plan are generally not subject to creditor claims.

Working owners of closely held corporations may find qualified retirement plans especially attractive. These shareholder-employees may benefit the most from a plan since they probably have the longest service in which to accumulate benefits. They may also be allowed a greater contribution because their compensation is likely to be higher than that of other employees. This is especially true if the shareholder-employee is the only participant or if contributions for other participants are small compared with those for the shareholder-employee. Long-term participants usually receive additional benefits from the forfeitures of the nonvested accounts of employees who do not stay with the employer long enough to become fully vested.

Qualified retirement plans appeal to employees because plan contributions are not currently taxed. Generally, earnings on these contributions also accumulate in the plan without current taxation. Employees are taxed when they receive a distribution from the plan. Another advantage for employees is the accumulation of retirement funds. Some plans (e.g., 401(k) plans) allow employees to make contributions from their compensation on a tax-deferred basis.

Disadvantages of Qualified Plans

The disadvantages to an employer of having a qualified retirement plan must also be carefully examined. To receive tax-favored...