Printer Friendly

Age-based pension plans approved, delighting small business owners.

Over the past five years, defined-benefit plans--those in which a retiree's benefits are specified--have become less attractive to both employee and employer. The plans have been depressed by federal legislation effectively reducing the size of their tax-deductible contributions and making their administration much more costly. But now, to the delight of many small business owners, what Congress has taken away with one hand the Internal Revenue Servie appearts to be giving back with the other.


As a replacement for the defined-benefit plan, many employers have been turning to the less complicated defined-contribution plan, which specifies the amoung of tax-deductible contributions to each employee's pension account rather than specifying the benefit to be paid. The invested pension funds' performance determines the eventual benefit amount at retirement.

Drawback. These plans, however, lock the employer into a fixed annual contribution. To compensate, many employers added profit-sharing to defined-contribution plans, which allows the employer to determine the amount of the annual contributions. Thus, in good years contributions can be high and in slow years can be adjusted downward.

As good as these combination plans are, some employers, especially small business owners, still were dissatisfied because IRS regulations generally prohibit pension plans from discriminating in favor of highly paid employees, such as business owners or top company officers. In general, all employees--young and old--are allocated almost equal shares.

As a result, many employers were asking if there was a way to discriminate in favor of older employees in a profit-sharing plan. Their argument was that, since older employees have fewer years to build up a pension fund, they should be allowed to contribute faster than the younger employees.

Proposed remedy. In 1990, the IRS issued proposed regulations for Internal Revenue Code section 401(a)(4), which deals with nondiscrimination requirements. Those proposed regulations said, in effect, a profit-sharing plan that allocates contributions based on age does not necessarily discriminate in favor of the highly compensated.


With the release of final regulations last September, the IRS confirmed that age-based allocations satisfying the technical cross-testing requirements, which are described in regulation 1.401(a)(4)-8(b), do not discriminate in favor of highly compensated employees.

Redrafting a pension plan based on employees' age has a dramatic effect on corporate contributions. Consider the comparison between a company's contributions in an age-based plan and a traditional allocation, as shown in the exhibit above. By allocating the contribution on the basis of age, the owner's contribution is increased by 54% while the total outlay remains about $39,000, yet the owner's contribution as a percentage of the total grows to 71% of the total from 46%.

Equally important, if the owner contributes less than $39,000, the amount allocated to his or her share remains at 71%.

While not all profit-sharing plans should have age-based contributions, clearly many small businesses can benefit, as this example shows. And in some cases, even midsized and large companies might benefit, depending on the employees' age spread.


In addition to allowing the older business owner to shelter more pension contributions, age-based profit-sharing pension plans have these pluses:

* The plan is easier and less costly to administer than a defined-benefit plan, which must meet many federal requirements.

* Unlike under defined-benefit plans, annual premiums don't have to be paid into the government-sponsored Pension Benefit Guarantee Corporation.

* Employers don't have to send annual actuarial certification to the IRS.

CPAs and actuaries, who will make the final determination on which pension plan is best for a business, should be aware that such an option as age-based profit-sharing exists.
COPYRIGHT 1992 American Institute of CPA's
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1992, Gale Group. All rights reserved. Gale Group is a Thomson Corporation Company.

Article Details
Printer friendly Cite/link Email Feedback
Title Annotation:Benefits/Compensation
Author:Cavooris, Bill
Publication:Journal of Accountancy
Date:Jan 1, 1992
Previous Article:How a workout specialist operates.
Next Article:What an auditor does when finding fraud or illegal acts.

Related Articles
Closer scrutiny of state and local plans by Sec. 415.
New compensation limit for qualified retirement plans.
The new $150,000 limit on qualified plan compensation.
Small business tax solutions.
Benefits for small business: Clinton plan could expand retirement coverage for up to 10 million workers.
Pension simplification finally arrives: the employee benefit provisions of the Small Business Job Protection Act of 1996.
Cash balance conversions.
Pension design can boost cash flow: defined benefit plans, far from being dead weight on the balance sheet, can be engineered to be tools for...
Class-based pensions: a cost-saving alternative for companies of all sizes.

Terms of use | Copyright © 2017 Farlex, Inc. | Feedback | For webmasters