Professional Services Accounting ARTICLE -
Is Your Firm’s Retirement Plan Adequate?

Target Audience: Legal Professionals, Professional Service Firms, Accounting Consulting Firm Interest and Topics, Working Capital and Capitalization Structures Interest

Savings Vehicles Can Help Make Up the Shortfall

Insufficient retirement funding affects a law firm, threatening its growth and survival. Partners have depended heavily on firm payouts for retirement. Younger lawyers may leave the firm if they receive less compensation because the firm is trying to make up for a shortfall.

Many firms use 5% to 20% of current profits for retirement payouts. Decreasing availability of funds will likely accelerate as baby boomer partners retire over the next 20 years. And firms will have difficulty quickly replacing the substantial revenue retired rainmakers brought in.

A partially or fully funded retirement plan could provide short-term help. Long-term answers may reside in savings vehicles that encourage partners and associates to invest.

Temporary and permanent solutions

Begin by considering how many partners will be retiring in the next few years and calculate the cost of those payouts. Next, review your revenue sources, such as current income or a retirement fund. Finally, look at different investment strategies to help you meet the cost and prevent impending retirements from consuming current profits.

Long term, your firm must decide how much it will contribute and which retirement plan meets your firm’s and lawyers’ needs. That won’t immediately solve your payout woes, but adding or expanding a retirement plan can help attract and retain younger partners and associates.

Retirement plan choices

Even if your firm can manage the financial burden of retirement payouts, savings plans offer tax benefits for firms and lawyers. Both qualified and nonqualified deferred compensation plans (whose tax treatments differ) may provide secure retirement funds and allow lawyers to defer taxes until they receive distributions.

Qualified plans offer tax deferrals for workers’ contributions until retirement and current deductions for firm contributions. And you may be able to use qualified plan provisions to favor highly compensated, older and executive firm levels. Note that you must offer the qualified retirement plan benefit to the entire staff, not just lawyers; otherwise, your plan could lose its favorable tax treatment.

By contrast, nonqualified plans let you tailor benefits to your firm’s or specific lawyers’ needs. Unfortunately, you may not be able to deduct contributions until lawyers receive distributions. Qualified and nonqualified savings vehicles include:

401(k) plans. This qualified plan allows participants to contribute pre-tax dollars — the lesser of $13,000 ($16,000 if age 50 or older) in 2004 (subject to certain limitations) — and benefit from tax-deferred growth until retirement. Additionally, lawyers can make penalty-free loans for items such as tuition and medical expenses under specific circumstances.

Although 401(k)s can have high administrative costs, they offer flexibility for employers and employees. For example, your firm can contribute a discretionary amount to a law firm’s 401(k) plan.

Profit-sharing plans. This qualified plan offers flexibility and possibly lower administrative costs. Plan contributions can be discretionary, so your firm can decide how much — based on each year’s results — to contribute to the plan. Limited discrimination in favor of the older, highly compensated, and executive groups may be permitted.

The maximum contribution as of this writing is 100% of compensation with a maximum contribution of $41,000 ($44,000 if age 50 or older) for eligible employees. Deductibility of the contribution, however, is still limited to 25% of eligible compensation.

Savings Incentive Match Plans for Employees (SIMPLEs). Though this qualified plan isn’t subject to discrimination tests, firms must contribute funds for all workers, either matching 100% of employee contributions up to 3% of salaries or contributing 2% per person. Participants can contribute up to $9,000 in 2004 ($10,500 for those 50 and older).

Defined benefit plans. These qualified plans provide set monthly payments to employees for life or a set period. Instead of separate accounts for each participant, an asset pool provides payments (or other benefits) to eligible participants. These plans may permit the highest annual contributions for certain participants, but there are funding strings attached.

Excess benefit plans. Qualified plans generally limit the amount employers contribute to workers’ plans. An excess benefit plan is intended to provide benefits not covered under qualified plans. These plans are subject to different rules and thus may favor certain partners or employees. Generally, the tax rules differ as well.

Shift some burden to partners

Traditional and Roth IRAs provide substantial tax breaks (now or later) while saving for retirement. Traditional IRAs allow holders to take an above-the-line deduction — in addition to the standard deduction or itemized deductions — for contributions up to $3,000 (the contribution limit in 2004 for traditional and Roth IRAs; $3,500 for those 50 and older).

Roth IRA holders enjoy tax-free growth and tax-free qualified distributions but miss out on current-year deductions. But if you contribute to a firm-sponsored 401(k) plan, phase-out rules probably would limit your traditional contributions’ deductibility anyway.

Balance firm and partner interests

Many law firms fund partner retirements. With our assistance, you can fund and reorganize your firm’s retirement plan as well as help partners and associates develop personal savings vehicles to ease your burden.

Find out how our expertise in professional services accounting can add value to your business. Email us or call us at 1 (888) 875-9770.

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