Profit sharing and other retirement programs are being used to reward and retain even young employees. The key is a short vesting schedule.
The year was 1982. The place was Charlottesville, Va., and Peter L. Sheeran, the 33-year-old president of Sheeran Cleveland Architects was fit to be tied. In less than a year, five of his seven full-time architects and designers had jumped ship for larger, more established firms. And he feared the rapid turnover would spell the end of his small, three-year-old professional corporation.
"I knew something had to be done," Sheeran remembers, "but I didn't know what." So he and his partner, Samuel S. Cleveland, sat down and ticked off their options. They could match competitors' offers of better pay. "A financial impossibility," they decided. They could take a crack at stock options. "An administrative nightmare," they figured. Or they could have a go at a profit-sharing plan.
"We wanted," Sheeran says, "to find a way to reward people, so that they knew the harder they worked, the more money they made. A profit-sharing plan seemed to fit the bill." That first year, Sheeran Cleveland's profit-sharing plan doled out a generous 50% of the firm's earnings to employees. In no time at all, productivity jumped. "People started working nights and coming in early," Sheeran recalls, "and they started taking on more responsibilities without the partners having to delegate it to them."
What's more, Sheeran Cleveland's turnover rate slowed down dramatically -- almost to the vanishing point. And the firm found itself in the enviable position of being able to recruit architects and designers from competing firms. "Usually," Sheeran says, "partners want the profits for themselves. Our profit-sharing plan set us apart from those other firms." The use of profit sharing and other types of retirement plans is, of course, not new. Pension programs in the United States date back to 1759, when a group of Presbyterian ministers adopted a plan to provide benefits to their widows and children.
What has changed about retirement programs is businesses' attitude toward them. In the past, small companies set up pension plans primarily to shelter income for business owners and key executives. Now, corporations treat retirement programs as bona fide management tools. Companies use them to attract new employees, to promote loyalty, and to reward productivity. The trick is to adopt a plan with a short vesting schedule.
Vesting, simply stated, is an employee's right to receive money from a pension plan, even if he or she resigns or is fired. A worker becomes vested after a specified number of years on the job, a number that is set by the employer within certain government-set minimum standards to protect the employee. The longest vesting schedules that are allowed under these standards -- and the least favorable from a worker's point of view -- are one of two types. Cliff vesting is an all-or-nothing method that entitles workers to full benefits after 10 years of employment. Short of 10 years, they get nothing. Graded vesting schedules vary widely, but the worst case for employees is called the "rule of 15." It entitles workers to only 25% of their retirement benefits after 5 years on the job, and builds up through annual increments to 50% after 10 years and 100% after 15 years.
Employees favor short vesting schedules, a preference that has been put to good use by Horticultural Creations Inc., in New York City. Founded in 1977 by Harold Wegweiser, the company leases houseplants to such corporate bigwigs as Citicorp, Merrill Lynch, and the Sheraton Centre Hotel. It also provides plant care to these companies.
Since its creation, Horticultural Creations has been plagued by a shortage of experienced workers, a situation that forced Wegweiser, the company president, to come up with a plan to retain the young workers he trained. Wegweiser's idea? A profit-sharing plan that calls for employees to be partially vested after two years and fully vested after six years.
What this means is that after only two years on the job, workers may borrow up to 20% of the money that is contributed to the profit-sharing plan in their behalf. At the end of six years, they are entitled to borrow the full amount. They can use the money as, say, a down payment on a house or a car. The primary requirement is that the loan must be repaid within five years; otherwise, it is treated as income to the employee and is subject to taxation.
Workers also have the option of leaving the money in the plan and allowing it to accumulate for their retirement. But most prefer not to go this route -- a fact that doesn't bother Wegweiser one bit.
"Your company is only as good as the people who work for you," he notes. "You can't grow without profits. To lock in profits," he continues, "you have to lock in employees. [I've] accomplished that with . . . a profit-sharing plan.
Generally speaking, retirement plans fall into one of two categories -- defined-benefit plans and defined-contribution plans. A defined-benefit plan provides employees and business owners with a specific amount of money upon retirement. In most cases, this figure is computed by using a formula that is based on an individual's length of employment and salary. But there are certain preset limits. Specifically, the new Tax Reform Act of 1984 caps annual benefits from a defined-benefit plan at $90,000. This ceiling remains in place through 1986.
With a defined-contribution plan, the contribution is fixed each year, so the benefits employees receive depend solely on the amount of money that accumulates in their behalf.
Typically, companies contribute from 7% to 15% of each employee's salary to a defined-contribution account. The annual ceiling on contributions to these plan through 1986 is $30,000 per person.
Small businesses generally opt for defined-contribution plans -- such as profit-sharing and employee stock ownership plans -- because these plans offer the flexibility of allowing companies to set the amount they will contribute year by year. You can increase or decrease your allocations depending on profitability. If you have a bad year, you are not stuck with a bill from your pension program.
As a rule, you shouldn't even consider establishing a retirement program unless your company is profitable. Also, you should make sure a pension program is something your employees really want. "Before installing a plan or other employee benefit," suggests Ira Lewis, a vice-president of Merrill Lynch, Pierce, Fenner & Smith in New York City, "informally poll selected employees to ensure that the program will be well received and will complement any other benefit programs."
Ask yourself too why you are establishing a retirement plan. Are you looking to provide an extra benefit for employees? Or are you hoping to shelter income for yourself? Most likely, say Tom Ference and Don DeGroff, of the accounting firm of Crowe Chizek & Co., in South Bend, Ind., the answer is a combination of the two.
Another key to the type of retirement plan you choose is the age of your employees, notes John B. Egner Sr., an attorney with The Johnson Cos., a Newtown, Pa., benefits-consulting firm. Young employees, like those at Horticultural Creations and Sheeran Cleveland, prefer defined-contribution plans.
Workers over the age of 40, meanwhile, fare better under a defined-benefit plan -- a fact that bothers some small businesses. Consider Akromold Inc., a privately owned Cuyahoga Falls, Ohio, manufacturer of molds for plastic automobile and household products. Back in 1967 the company adopted a defined-benefit plan, but now it is revamping the program. It considers the plan unfair. "Employees who started working at the company when they were 50 were receiving the same benefits as those who had been with the company since they were 20," explains Robert Monteith, the corporation's employee relations manager. "Our 20-year veterans were not being rewarded for their loyalty."
Another important issue to decide in setting up a pension plan is who will be covered. "Think about who has performed valuable service to your company in the past," advises Lewis, "and who is most important to ensure its future success."
Finally, don't even toy with the idea of managing your pension money yourself. You probably can't afford to spend more than 5% of your time on pension matters -- and that isn't enough, given our complicated tax and pension laws. What's more, retirement money isn't something to be played with.
"You've got a lot of people," says Lewis of Merrill Lynch, "who carry the entrepreneurial spirit right into managing their money." That, he adds, isn't such hot idea.