New Company Benefit Seen From IRS Ruling

Firm allowed to put unused vacation into 401(k) plan

Here's some unexpected cheer from - would you believe? - the US Internal Revenue Service:

Thanks to a ruling by the IRS, you may someday be able to have the value of your unused vacation days added to your company retirement plan. And you may be able to do it even if you have already kicked in the maximum level of contributions allowed in 401(k) plans, which is currently $9,500.

The vacation-day ruling was first reported in the Wall Street Journal on Dec. 10. Not surprisingly, phones are now ringing off the hooks in many retirement-plan offices, says one corporate-benefits expert, as workers and retirement managers in other companies ask, "Why not us, too?"

The ruling was "technical advice memorandum 9635002" - issued to an unidentified business by the national legal affairs office of the IRS.

The ruling grew out of a tax audit. Although the main issue in the dispute involved company payroll taxes, the ruling went on to give a green light to the company to add the dollar value of unused vacation days to workers' 401(k) retirement accounts.

Broader ruling needed

The new ruling could be important for large numbers of American workers, says Dennis Coleman, a principal at Kwasha Lipton, a benefits consulting firm in Fort Lee, N.J. But don't look for the vacation-day benefits at your own company any time soon, he cautions. For the ruling to be broadened, the IRS would have to either approve additional companies on a case-by-case basis or issue a general-revenue ruling that would apply to all US companies. A broad decision by the IRS is unlikely before late 1997, he predicts.

"This is a decision currently applying to just one specific US company," explains an IRS spokesman.

Still, whether acting intentionally or inadvertently, the IRS has now kicked open the door to an entirely new type of worker's retirement benefits, says Coleman. Other firms can be expected to ring up the IRS, asking for a similar vacation policy. Moreover, the IRS is expected to have to eventually resolve whether to limit the vacation-days benefit to 401(k) plans - which are retirement plans at private-sector companies - or expand the concept to include nonprofit organizations that have 403(b) plans.

"I can see no reason why companies with 403(b) plans couldn't also" adopt the vacation-day policy, says Martha Priddy Patterson, a Washington benefits consultant at KPMG Peat Marwick LLP, an accounting/consulting firm.

The distinction between the two types of plan, 401(k) and 403(b), has been increasingly blurred in recent years, says one New England-based benefits manager. Many companies with 403(b) plans, for example, now have the option of converting to a 401(k) plan. Also, under new rules, companies with 403(b) plans can, if they wish, allow employees to change their benefits package more than once a year. That flexibility is a major component of 401(k) plans.

Currently, most workers face three options regarding unused vacation days: (1) forfeit the days if they are not used within a calendar year, (2) carry the days over into the next calendar year, or (3) have the value of the days converted into "cash" by the company.

Rolling the value of unused vacation days into 401(k) plans would be a new twist. It would protect the money from taxes until withdrawn after retirement. And what about unused sick days or personal days? Could they too be rolled into the 401(k) plan?

Coleman sees the new vacation-day option as a "win-win" for both employers and workers. Many workers, reluctant to forfeit vacation days, take them at the end of the year, thus substantially reducing their firm's work force. The new policy would encourage workers to stay on the job, he says. And workers would be able to boost their retirement savings.

Studies by KPMG Peat Marwick show that only about 5 percent of all employees contribute the maximum annual allowable amount to their 401(k) plans.

Specific requirements

To win approval similar to the currently approved plan, companies would have to make certain that the vacation contributions were "non-elective employer contributions to a qualified plan," Ms. Patterson says. In other words, the workers in the approved plan did not have the option of choosing cash or some other taxable benefit instead of the company's contribution to the retirement plan. While the benefit might appear to be part of the 401(k) plan, it was really tucked in a separate compartment linked to the retirement plan, she says.

Ms. Patterson sees two major hurdles to widespread acceptance of the vacation plan: First, many employees now forfeit their vacation days, which in effect costs a company nothing. Under this new arrangement, companies would have to make a dollar-value contribution to the retirement plan. That means added expenses for the company. Second, the plan, as noted, could allow higher-paid executives to kick in far more than the $9,500 annual limit on 401(k) contributions. That could be seen as discriminatory to lower-paid employees. 401(k) plans have strict antidiscrimination rules to which companies must adhere.

Still, many workers may see the possibility of adding the value of vacation days to their retirement plans as an exciting new type of "company benefit" that can boost their total retirement assets.

Stay tuned.

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