Introduction A summary of the range of schemes available in the US

Profit Sharing Plans And Eligible Individual Account Plans (EIAP) An EIAP is a form of profit sharing plan which can be designed to permit up to 100% of trust assets to be invested in employer securities.

401(k) Plans

A 401(k) plan permits employees to choose to defer a portion of their wages on a pre-tax basis. The 401(k) plan must be part of a qualified profit-sharing plan, a stock bonus plan, a pre-ERISA money purchase pension plan, or a rural cooperative plan. A 401(k) plan frequently features an "employer matching" provision in which the employer makes a contribution to the plan equal to (a certain percentage of) the employee's contribution. This serves to encourage participation among employees at all levels.

The company usually offers at least four alternative investment vehicles. Because the law requires that participation in the plans not be too heavily skewed towards more highly paid people, companies generally offer a partial match to encourage broad participation in these voluntary plans. This match can be in any investment vehicle the company chooses, including company stock. There is a combined limit of 15% of taxable pay that the company and the employee together can contribute to the plan. For example, if an employee is making $30,000 per year and contributed $2,000 to the 401(k), the combination of the employee's $2,000 contribution and the company's match cannot exceed 15% of $28,000 ($4,200). This 15% limit is further reduced by contributions to other tax-qualified retirement-oriented benefit plans.

Some 401(k) plans give employees the choice of investing in the company they work for. Employers offer company stock in a 401(k) plan for several reasons. Some believe that making employees part-owners of the company will give them incentive to work harder to make the company succeed, and a greater feeling of satisfaction when it does. Also, when employers use company stock to make matching contributions it is less expensive for them than using cash, for tax reasons. For the employee, the tax benefit comes on retirement - if a distribution of company stock is taken then, the retired employee will pay income tax on what the stock was worth when it was acquired, not what it is worth at the time of withdrawal.

For closely held companies, 401(k) plans are less appealing, although very appropriate in some cases. If employees are given an option to buy company stock, this can often trigger securities law issues most private companies want to avoid. Employer matches make more sense, but require the company to either dilute ownership or reacquire shares from selling shareholders. In many closely held businesses, the first may not be desirable for control reasons and the second because there may not be sellers. Moreover, the 401(k) approach does not provide the "rollover" tax benefit that selling to an ESOP does, and the maximum amount that can be contributed is a function of how much employees put into savings. That will limit how much an employer can actually buy from a seller through a 401(k) plan to a fraction of what the ESOP can buy.

The major benefit to employees of the 401(k) plan is that they are not taxed currently on the portion of compensation that is placed in the plan. An employee has the option of choosing between cash or future benefits on a year-to-year basis. In addition to the tax deferral, another major benefit is that a 401(k) plan is eligible for five-year averaging on distributions. But, if an early distribution is taken, the amount is subject to an additional 10 per cent tax.

Because a 401(k) plan is a qualified plan, it is subject to the same rules imposed by the Internal Revenue Code and ERISA as are all other qualified plans.

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