Pension Plans: Company contributions to such plans are deductible as costs ofoperations, and hence they are provided from "before tax"funds. Other advantages are that interest earned on pensiontrust funds is tax exempt, and depreciation in value of theassets in the pension trust is not subject to capital gains tax. Thus, a company can help its employees build retirementprotection at great savings.
From the standpoint of the employee members of the company pension plan, company contributions, while deductible tothe employer, are not income to the employee until such timeas they materialize as retirement benefits. Therefore, when thefunds ultimately are paid out as annual pension, the employeepays taxes on an income that is less than his current incomeand generally is taxable at annuity rates. The tax after retirement is generally in a lower bracket and a saving is effected in that respect as well.
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At the same time, to the extent that the employee himselfhas contributed to the pension fund out of his annual income,he pays no taxes whatever, since this is income that hasalready been taxed. If the retirement payments are made tothe employee in a lump sum from the pension fund, theeffective tax is limited to a maximum of 25%the capitalgains figureregardless of total income.
In order for these tax savings to both the employer and theemployee to materialize, however, a pension plan must qualifywith the Internal Revenue authorities, subject to the technical rules and standards defined in the Internal Revenue Code. Forexample, a pension plan may not discriminate in favor of managerial or executive personnel and it must observe the operative limitations on the percentage of an employee's annual compensation which may ultimately be paid out as apension.
In order to have a pension program, a company need notbe large. Although the trend today is away from self-adminis tered pension trusts to trusts funded through annuity insuranceplans, often combined with investment trusts, recent congressional enactments have facilitated the establishment of pensionplans for small businesses and professional offices. The plan can be contributory on the part of the employees, or can beabsorbed by the employer. The advantages to employees of animproved pension plan are not easily matched by privatesavings.
Self-employed Individuals and the Keogh Act Plans: Forlong years, the self-employed business or professional mansuffered unprotected and unthought-of while his Governmentmoved in every way to provide for the country's workers and, through subsidies, the country's farmers and corporations. Thegradual extension of Social Security to self-employed personsrepresented one breakthrough. The passage in 1960 of HR10,the so-called Keogh Act, however, was a major victory. Forthe first time, the opportunity to build retirement benefits on atax-deductible basis was offered to the self-employed person aswell as to the corporation.
Until 1968 the Keogh Act was fairly rigid. An individual's contribution to a retirement plan was restricted to 10% ofhis earned income up to $2,500 per year, and only 50% of theamount allocated to his annuity or retirement program wastax deductible. Legislation passed in 1966 greatly liberalized both the substance and the method of self-employed pensionplans, the most important aspect being the right to deduct100% of the annual contribution (up to $2,500) beginning in 1968. For doctors, attorneys, and single entrepreneurs, theKeogh Bill affords real opportunity to enjoy tax shelter while laying away money for retirement. Moreover, the investment alternatives are varied and broad annuities, life insurance en dowment contracts, mutual funds investments, bank accounts,trust accounts, or combinations of insurance and investmentarrangements.
Under the provisions of the Keogh Act, a self-employedperson, including the members of a partnership, may contribute 10% of his earned income, or a maximum of $2,500whichever is less, in one of the plans, or in one of thecombination of plans approved by the Internal Revenue Ser vice. For tax years beginning on or after January 1, 1968, theself-employed person may deduct from his taxable income theentire amount which he has contributed to his investment-re tirement plan. During prior tax years, ending on or before December 31, 1967, only one-half of the contribution was taxdeductible. Now, however, the entire amount put aside under the retirement plan is deductible from gross income hi determining taxable income.
However, the self-employed person, or the partners of afirm, must also make similar contributions for all qualifiedemployees in the service of the employer for three or moreyears.
If you are John Constantine Higginbotham, a partner in thefirm of Higginbotham, Beelzebub, and Montmorency, and youwant to make a contribution to your pension plan, Mr. Montmorency and Mr. Beelzebub must also join in the plan. If youhave Miss Sally Typefast, who has been with your firm for four years, she must be included. The two other secretarieswho have been there for only one year and two years, neednot be included; but any employee who has been with the firmfor three or more years must be included or the plan will notbe approved. If one partner refuses to participate, the InternalRevenue Service will not approve the plan.
If you are an employee of the firm, you may be permittedto make contributions in addition to the amount contributedby your employer. If your salary is $5,000 a year, and your employer contributed $250 a year, you yourself may then contribute an additional $250. In making the contributions,however, your employer may not decrease your wages. Hemay, however, make excess contributions under limited conditions as, for example, where he uses the "insurance type" of investment plan and his income drops so that his current contribution would be more than 10% of the average income over the last three-year period. Under such circumstances, he may continue to make the same contribution even though it isin excess of 10% of the earned income, but he may deductfrom his taxable income only that portion which is 10% of theearned income.
If you are self-employed, and you make contributions toyour retirement plan, you may not withdraw these contributions until you have reached the age of59^2 (insurance age60). There is also a limit on how long all of the benefits mayremain in the plan, and when you reach your "insurance age70," you must start to draw benefits and may make no more contributions to your retirement plan.
If you die before you draw any benefits, the total due toyou will be paid to your beneficiaries within five years after
your death. If you become disabled, you may draw thebenefits in a lump sum or over periods of time which will varydepending upon the terms of the investment plan. When thebenefits are paid, they are taxable to you to the extent that they were not taxed at the time the contribution was made. The tax advantage is that they will be taxed at a lower rateand in a lower bracket than that in which you were includedat the time you earned the money which went into the taxplan. The benefits are taxable as ordinary income, but since inretirement or semiretirement you will be hi a lower taxbracket, there is a considerable saving involved.
If the provisions of the Keogh Act are complied with, theself-employed person is given the opportunity to earn tax-deductible deferred compensation, and to avoid the higher taxrate of his more productive years. The contributions to the retirement plan will be taxed when they are paid out, aftermaximum earning years have passed, and when the taxpayeris in a lower bracket. At the same tune, the funds in theinvestment plan continue to earn income which will not betaxed until it is actually received.
