If you're having trouble deciding which retirement plan to adopt for your firm, you're not alone. Many busy attorneys have put critical retirement planning decisions on hold for fear of making the wrong call.
This article is designed to help law firms--especially small law firms--sort through the alternatives and identify a plan that meets the retirement planning objectives of the principal partners or solo practitioner. For clarity of discussion this article refers to both solo practitioners and principal partners as "principals."
From SIMPLE to complex
While maximizing tax benefits may be the primary reason for choosing a retirement plan, other important factors include how much it costs in time and money to administer the plan and how much the firm will be required to contribute on behalf of its employees. No single retirement arrangement is right for all firms.
This article focuses on the three most popular types of tax-favored retirement plans for small firms: simplified employee pension plans, commonly called "SEPs;" savings incentive match plans for employees of small employers, referred to as "SIMPLE IRAs" and "SIMPLE 401(k) plans;" and qualified profit-sharing plans.
These range from simple plans--as their names imply--that require little employer maintenance to complex arrangements that require substantial professional assistance (e.g., in maintaining participants' account records, complying with IRS and Department of Labor reporting requirements, and the like).
For many small firths, a SEP or SIMPLE arrangement will be adequate. For other firms, particularly those at which top salaries are relatively high, the more complex arrangements may provide principals with greater tax savings at a lower total contribution. A condition of these plans is that tax benefits be provided to at least a large portion of the employer's workforce. Accordingly, firms must make substantial contributions on behalf of their employees. Both the choice and the design of the plan will affect the cost of these contributions.
While the requirements imposed on SEPs and SIMPLEs are straightforward, they also limit the firm's flexibility to design a retirement plan that meets its objectives. Firms have much greater freedom to structure a qualified profit retirement plan, but such a plan is also subject to complex regulations designed to ensure that it doesn't unduly favor highly compensated employees.
This article describes the major features of SEPs, SIMPLEs and qualified profit-sharing plans and identifies practical considerations in choosing one over the others.
Simplified employees pension plans
The good news: simplicity. The SEPs big advantage is that it is relatively easy to implement and maintain. You can adopt one by using a SEP prototype furnished by a financial institution--or by executing an IRS Form 5305-SEP yourself--and creating an individual retirement account (IRA) for each eligible employee. Typically, your firm won't have to administer the IRAs or monitor their investments, nor will you have control over or responsibility for making distributions.
SEPs are also generally exempt from IRS and Department of Labor annual reporting requirements, unless 1) the firm influences its employees to contribute to a particular IRA and 2) the IRA imposes restrictions on withdrawals in addition to IRS penalties. Firths are required to provide employees with a copy of the SEP documents and other information.
The bad news: elective contributions not allowed. SEPs typically don't permit employees to make their own contributions, unless the SEP was established as a salary reduction SEP (a SARSEP) prior to 1997. This makes a SEP an unattractive option for most firms.
Salary reduction contributions allow employers to shift a portion of the cost of pension contributions from the firm to its employees. In the case of many firms, if they are not able to pass that cost back to employees in the form of lower...