Must employers provide their employees with retirement benefits?

Employers are not required to establish retirement plans, although most must participate in Social Security. Nevertheless, one of the most significant developments in business and industry during the middle of the twentieth century has been the astonishing growth of employee retirement plans as an integral part of the employer-employee relationship.

In 1960, 66 percent of plant workers and 76 percent of office workers were covered by a retirement pension plan. By 1976, the figures had risen to 79 and 86 percent respectively. While 86 percent of the major U.S. employers surveyed had a defined benefit pension plan in 1990, 84 percent offered one in 1995. In 1990, 94 percent offered their employees salary reductions through a 401(k) plan, while 98 percent did in 1995.

There are strong advantages and disadvantages to offering retirement benefits.

What are the advantages to offering retirement benefits? Here are some reasons why an organization might want to offer a retirement plan:

It can receive some significant tax advantages because Congress wants to encourage employers to provide retirement benefits to employees.
If the plan is based on profits, the plan may enhance employee motivation and productivity.
Retirement benefits may give the organization a recruiting advantage.
If the business has high start-up costs or little cash on hand, a retirement plan can supplement founders' compensation packages.

What are the disadvantages to offering retirement benefits? Here are some reasons why an organization might want to forego offering a retirement plan:

Setting up and administering a plan can be time-consuming, complicated and costly.

Providing a plan can (and most likely will) require professional assistance, which can be expensive.

More than likely, if a business is just starting up, it will have greater worries than the intricacies of a retirement plan. If anything, there are other less burdensome, more valuable benefits that can be provided to employees, such as health insurance, time-off benefits, disability insurance, and life insurance. If a retirement plan is under consideration, make sure you understand the basic differences in plan types.

What are the basic types of retirement plans? There are two major categories of pension plans: qualified plans and nonqualified plans [see "What is the difference between qualified and nonqualified plans?" at 47,230].

Qualified plans meet the requirements of the Employee Retirement Income Security Act of 1974 (ERISA) and the Internal Revenue Code and qualify for four significant tax benefits.

The income generated by the plan assets is not subject to income tax, because the income is earned and managed within the framework of a tax-exempt trust.
An employer is entitled to a current tax deduction for contributions to the plan.
The plan participants (the employees or their beneficiaries) do not have to pay income tax on the amounts contributed on their behalf until the year the funds are distributed to them by the employer.
Under the right circumstances, beneficiaries of qualified plan distributions are afforded special tax treatment.

Nonqualified plans are those not meeting the ERISA guidelines and the requirement of the Internal Revenue Code. They cannot avail themselves of the preferential tax treatment. Nonqualified plans are usually designed to provide deferred compensation exclusively for one or more executives.

Retirement plans are also divisible into the following broad categories: