Employers find something better than IRAs for retirement savings

With all the hoopla over individual retirement accounts (IRAs), it seems impossible there could be anything better.

But many employers are convinced there is indeed a better way to help employees put aside money for retirement, and they are badgering benefits advisers for information on the alternative.

The alternative goes by a variety of names, including cash or deferred arrangements (CODAs), and 401(k)s, after the section of the Internal Revenue Code that authorizes them. But they are most commonly known as salary reduction plans.

''Just about every large company in the country is thinking about a salary reduction plan or is close to putting one in,'' said Lloyd S. Kaye, vice-president and senior legal counsel at William M. Mercer Inc., a benefits consulting firm.

Companies that aren't thinking about these plans may have to, once their employees find out about them. After all, salary reduction plans cut income taxes by setting aside pretax income and building up tax-free interest until retirement; allow you to put away more money than an IRA; and still let you get at the money in an emergency, without having to pay a penalty.

The plans permit workers to put 10 percent - sometimes more - of their salaries into a company profit-sharing or savings plan. By contrast, the maximum contribution for an IRA is $2,000.

Instead of simply making a contribution to a savings plan, such as an IRA, salary reduction plans permit employees to actually take some of their wages off the top. For tax purposes, the money is then treated as a form of company contribution to a thrift plan, which means lower federal and social security taxes. Often, it means lower state taxes, too. Lower social security contributions may result in slightly lower benefits at retirement, but this could be made up by the added income from the savings plan.

Employees are not the only ones who gain from these plans, points out Donald Hasdargen, of the Minneapolis office of Hewitt Associates, a benefits consulting firm. Employers benefit, too, because for all employees participating in the plans and earning less than $32,400--the maximum pay subject to social security withholding--the employer has to pay a little bit less in social security taxes.

A worker earning $24,000 a year, for instance, would normally pay $134 a month in social security taxes. His employer would match that. But with a salary reduction plan in effect, the monthly burden is cut to $126, an $8 saving for both the worker and his boss, according to Buck Consultants Inc., a New York benefits consulting firm. That assumes a 6 percent contribution into the plan.

This may be one reason, Mr. Hasdargen says, that ''a lot of the pressure to put in salary reduction plans is coming from top management. Usually, the pressure for new employee benefits comes from the rank and file and works upward.''

Another reason, he believes, is that the higher a person's pay, the greater the tax advantages to be gained from a salary reduction plan.

As a result, ''there's been an enormous amount of interest in these kinds of plans,'' Mr. Hasdargen said. A recent seminar on them drew executives from 65 of the largest companies in the Minneapolis area, he noted.

One Minneapolis company that Hewitt Associates helped in setting up a salary reduction plan is Honeywell Inc. Since Honeywell's plan went into effect the first of this year, Mr. Hasdargen said, more than half of the employees have signed up for either the salary reduction plan, the IRA plan, or both.

At FMC Corporation of Chicago, the response has been even better. There, employee participation in the company's non-tax-free thrift plan doubled from 42 percent to nearly 85 percent when the tax-free salary reduction plan went into effect April 1, said Virgil Hare, director of FMC's compensation and benefits division.

He listed several reasons for the good response. For instance, if the company makes partly matching contributions, the money set aside can amount to as much as 12.5 percent of an employee's wages, ''all on a before-tax basis.''

In addition, when employees in salary reduction plans quit, retire, or reach age 591/2, they can withdraw the money and usually pay a much lower tax on the withdrawals than they would pay with IRA distributions. This is because 401(k) plans carry a 10-year carry-forward provision, permitting the tax burden to be diluted over a decade.

And unlike IRAs, which require a 10 percent penalty plus tax for early withdrawals, salary reduction plans permit penalty-free withdrawals in case of a ''hardship.'' While the Internal Revenue Service has not specifically defined hardship, it is generally agreed to mean an ''immediate and heavy need,'' a criterion that can permit a fair amount of flexibility for the employer and employee.

Interestingly, Mr. Hare says, the constant publicity about IRAs has only helped salary reduction plans. ''When people see all the ads for IRAs,'' he said , ''they are reminded of their company plan and how much better it is.''