Retirement Plan Challenges for Law Firms
Law firms often have compensation structures that are more complex than those of other business types. This is attributable to having both equity and non-equity partners, large year-end bonuses, variable associate compensation, and high contribution goals for senior attorneys -- all these factors and more affect how a retirement plan operates.
While these structures can create opportunities for sophisticated retirement plan design, they can also create testing volatility and compliance risk, especially if changes in compensation (or partnership/ownership) are not addressed throughout the year as they occur.
Bonus Inclusion and Compensation Definitions
An employer’s retirement Plan Document defines which types of compensation are included for employee deferrals, employer contributions, and nondiscrimination testing.
For many law firms, bonuses represent a significant portion of annual compensation. How bonuses are treated within a retirement plan can materially impact both participant contributions and compliance testing. Problems can arise when payroll practices do not consistently follow those definitions.
For example, a year-end bonus that is included for one purpose but incorrectly excluded for another could affect contribution calculations or testing results. Depending on the circumstances, the result may be:
- Actual Deferral Percentage ("ADP") or Actual Contribution Percentage ("ACP") testing failures
- Refunds to Highly Compensated Employees (HCEs)
- Unexpected employer contributions
- Corrective contributions for affected employees
- Additional administrative work and correction costs
For firms with significant year-end compensation, waiting until annual testing is performed to identify these issues can leave relatively little time or flexibility to address them.
Partner Status and HCE Monitoring
Law firms also frequently experience changes in ownership and partnership status. Associates become partners, non-equity partners move into equity positions, and partner groups change as attorneys join or leave the firm.
These changes can affect retirement plan testing and contribution strategies.
HCE status is based on ownership and prior-year compensation, making it important to understand how changes within the firm may affect an individual's classification. A newly-admitted equity partner, for example, may need to be classifieddifferently than an associate or non-owner attorney.
Proactive monitoring helps the firm understand how these changes could affect nondiscrimination testing before year-end rather than discovering the impact after the plan year has closed.
Cash Balance and Layered Plan Strategies
For firms seeking higher contributions for partners and senior attorneys, a traditional 401(k) or profit-sharing plan may be only one piece of the retirement strategy.
Many law firms combine a 401(k) and / or profit-sharing plan with a Cash Balance or other Defined Benefit Plan. When designed appropriately, these arrangements can create significantly greater contribution opportunities while helping the firm meet broader recruiting, retention, and retirement objectives.
However, layered plan structures also require careful coordination. Contributions under the different plans cannot be viewed in isolation. Demographics, compensation, ownership, contribution levels, and annual nondiscrimination requirements all need to be evaluated together. Changes in partner compensation or staffing can materially affect results from one year to the next, which makes annual projections particularly valuable.
Growth Can Increase Plan Scrutiny
As a law firm grows, retirement plan administration often becomes more complicated as well.
Additional attorneys and staff mean more eligibility events, compensation data, payroll activity, and potential operational errors to manage. Depending on the plan's participant count and other applicable rules, growth may also trigger additional Form 5500 reporting and audit requirements.
Even before an audit is required, though, maintaining accurate records and consistently following the plan document is critical. Payroll practices, compensation definitions, eligibility, contributions, and participant data should all align with the plan's written terms.
The Bottom Line
For law firms, retirement plan administration should account for the way the firm actually operates.
That means aligning administration with bonus cycles, anticipating partner transitions, projecting testing results before year-end, and coordinating 401(k), profit-sharing, Cash Balance, and Defined Benefit strategies when multiple plans are involved.
With proactive administration and regular plan design reviews, firms can identify potential testing and compensation issues earlier, reduce the likelihood of unexpected corrections, and ensure the retirement plan continues to support both the firm's partners and its employees.
The good news is that the same complexity that can create administrative challenges can also create significant plan design opportunities. With an experienced TPA helping the firm navigate compensation, ownership, testing, and contribution requirements, law firms have considerable flexibility to design a retirement program around their specific goals—whether that means maximizing partner contributions, improving employee benefits, supporting recruiting and retention, or creating a more effective long-term retirement strategy.
