Academic journal article Journal of Accountancy
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. …