Return To 401(k) & Annuities            

The Basics: Employer contributions to the plan are not dependent upon profits, and the plan may, but is not required to, invest primarily in employer stock.

1. Employer contributes to the plan.
2. Employer contributions are tax deductible. IRC Sec. 404(a)
3. Contributions are not taxed currently to the employee. IRC Sec. 402(a) and 403(a).
4. Earnings accumulate income tax-deferred. IRC Sec. 501(a)
5. Distributions can be tax-favored (eligible for 5-year forward averaging or rolled over into an IRA) at retirement. IRC Sees. 402 and 403.

Individual Limits: The allocation of contributions to a participant's account may not exceed the lesser or 25% of includable compensation or $30,000 per year.

Employer Contributions

1. Most plans are discretionary as to the amount which the employer contributes.
2. If there are profits, the employer is expected to make "substantial and recurring" contributions. As a rule of thumb, contributions during three out of five years or five out of 10 years will usually gain IRS approval.

Excluding Persons: Certain persons can be eliminated on the basis of months of service, age, coverage in a union plan, and salary base; for example, persons under age 21 can be excluded from the plan.

Investment of Plan Assets: Investments must be diversified and prudent. Subject to plan provisions, plan assets can be invested in equity products like mutual funds or stocks; or debt instruments like T-Bills and CDs. Insurance products like life insurance and annuity policies may also be used. Stock bonus plans typically are heavily invested in employer stock. They are not, however, required to invest in employer stock as with an ESOP.

Social Security Integration: Since the employer already contributes to the employee's Social Security retirement benefit_, these contributions can be integrated into the contribution formula of the plan

Parties which are Favored: Typically younger participants are favored because they have a longer time for their fund to grow.

Forfeitures: As participants leave the company and separate from the plan, those less than 100% vested forfeit that part of the account in which they are not vested. The nonvested forfeitures may then be allocated to the remaining participants. Those participants who remain in the plan the longest will share in the most forfeitures.

How Much Will There Be At Retirement?

The risk of poor investment returns rests upon the employee. However, if the investment results are favorable, the participant will have a larger fund at retirement age.

If more than 60% of the plan assets are allocated to "key employees," the employer must contribute at least as much for "non4'ey" participants as it does for key employees. This requirement applies only to a contribution of up to the first 3% of ineludible compensation (higher in some instances).

1. Contributions are tax deductible.
2. Contributions and costs are totally flexible.
3. The plan is easy to understand by the employees.
4. It can provide employees with permanent life insurance benefits that need not expire or require costly conversion at retirement age.
5. Since all or substantially all of the assets are invested in employer's stock; this is a good method for raising additional capital without going to the marketplace.
6. In effect the corporation can raise capital with deductible contributions to its plan.

1. Annual employer contributions are not taxed to the participant.
2. Earnings on the account are not currently taxed.
3. Distributions at retirement may be tax-favored.
4. Participants can also have a traditional, deductible IRA or a Roth IRA, subject to certain income level limitations based on filing status.
5. There is the ability to purchase significant permanent life insurance, which is not contingent upon the company group insurance program. Purchase of life insurance will generate taxable income to the employee (PS 58).
6. Younger employees can accumulate a larger fund than with a Defined Benefit Plan.
7. The forfeited, unvested portion of accounts of former participants may be allocated to the active participants accounts. This can have a substantial impact on the future benefits.
8. Employee can borrow from the plan within certain guidelines if provided for in the plan documents.
9. Employee participates in employers growth.
10. A potential market is created for stock of deceased shareholders.
11. At distribution, the gain on the stock is not taxed until it is sold.

1. The stock bonus plan will generally not produce as large a contribution and deduction for older employees as will a defined benefit plan or other types of defined contribution plans.
2. Contribution limitations are set at 15% of covered payroll.
3. If the company's stock is not publicly traded then the voting power of the stock must be passed through to the participants on matters requiring a majority vote of the shareholders.
4. The cost of having the value of closely held stock determined each year may be costly.
5. Future repurchases may not come at a convenient time.

1. There is no guarantee as to future benefits.
2. Investment risks rest on the participant.
3. Older participants will not receive as large a benefit as with a defined benefit plan.
4. There is no assurance as to the frequency and amount of employer contributions.
5. The value of closely held stock may be difficult to determine at retirement age.
6. If the founder or other key people die, retire or terminate employment, the company stock may be worth very little.
7. The company may not be financially able to repurchase the stock, even though required to do so.
8. If the employer's stock is depressed in value at retirement time, there could be a significant loss in the retirement account.