PROFIT-SHARING PLANS are established in an atmosphere of high hope and expectations of permanence. Many of them-and the ones the subject of this article-contemplate the deferment of payments until the participants retire. Like pension plans, however, some profit-sharing plans succumb in their youth.

The Bureau of Labor Statistics is concerned with the magnitude, causes, and consequences of these terminations. Deferred profit-sharing plans form a substantial part of all defunct retirement plans; 3,655 of the 8,069 qualified plans terminated during the 1955-65 period tied employer contribu

In all these characteristics, profit-sharing plans resemble pension plans. The number of profitsharing terminations increased more rapidly than did pension terminations because of the greater increase in the number of profit-sharing plans. Pension terminations substantially exceeded profitsharing terminations during the late 1950's, but the total closed out during the 1960's was about the same for both. (See chart 3.)

highest mortality rate occurred among plans that were young and small in size. More than half were less than 6 years old; 3 out of 5 covered fewer than 25 employees. Company and plan mergers, financial difficulties, and business dissolutions were cited most frequently as the reason for termination.

The quarter of a million employees covered by these plans at the time of termination incurred no loss of earned benefit rights because profit-sharing participants are promised only their proportionate share of fund assets, rather than specific benefit amounts. Moreover, Internal Revenue Service regulations require full vesting of these interests. The participants in many plans were, nevertheless, affected adversely. Unless coverage was continued in another plan, they could not earn additional benefits for future employment.

Profit-sharing terminations increased markedly between 1955 and 1965, but there was little change in the rate of termination, as shown in the table. More than twice as many plans were discontinued in the last half of the period than in the first half, but this increase just kept pace with the initiation of new plans. Although the rate fluctuated, about 1.4 percent of the active plans were, on the average, closed out each year. Looking at the reasons given for termination, and the economic prospects ahead, there is little reason to expect this pattern to change in the coming decade.

7 8

Profits and Plan Growth

Profit-sharing experience did not reflect the influence of changing business conditions to the extent that pension experience did. For example, the greatest rise in the number of pension terminations occurred in 1961, a year of relatively low economic activity, and the number of terminations fell during the following year of general recovery. Profitsharing terminations, on the other hand, rose in both years, with the greatest increase occurring in 1962. An employer's obligation to contribute to a pension plan is not related to the company's financial condition. Contributions must be made each year, unless previous contributions and investment earnings provide funds in excess of minimum IRS funding requirements. Profit sharing is more flexible in this respect. Contributions are tied to company profits; in years of little or no profit, no contribution is made. Age and Size

Only a fifth of the plans discontinued during the 1955-65 period had been in existence for 10 years or longer. While those proportions may gradually grow smaller as the system of retirement plans reaches greater maturity, higher mortality will probably continue to prevail among newer plans, since plans (like businesses) tend to be less stable during their early years.

Most of the terminated plans had relatively few members. One out of 3 terminations affected fewer than 10 employees and 7 out of 8 affected fewer than 100. This high proportion of small plans largely reflects their prevalence within the system. However, a higher rate of termination among small plans also would be consistent with the tendency of small firms to be less stable than large firms.

On the average, profit-sharing terminations involved slightly newer and larger plans than did pension terminations. The median age of termi-, nated pension and profit-sharing plans was 6 and 5 years respectively. Their median size was 13 and 18 members. The age differential, in large part, reflects the greater age of the pension system. A higher proportion of the existing pension plans were established before the period studied. Available data do not suggest an explanation for the size differential.

Reasons for Termination

Although a variety of circumstances were re sponsible for the termination of profit-sharing plans, sales and mergers, were cited most frequently as the primary reason. The sales of companies and individual plants and the merger of companies and plans accounted for 2 out of 5 terminations. Financial difficulties and business dissolutions were listed about half as often. All of the other reasons were far less prominent; none accounted for more than 4 percent of the total.

Mergers and sales, financial difficulties, and business dissolutions also accounted for most pension plan terminations during the 1955-65 period. However, only business dissolutions were equally important among pension and profit-sharing terminations. Financial difficulties were cited less frequently by profit sharing than by pension plans (1 out of 5 compared with 1 out of 4). This proportion is consistent with the relative flexibility provided by their respective contributory requirements during adverse circumstances. As mentioned previously, linking contributions to profits has made profit sharing more sensitive to a company's financial conditions. Mergers and sales were given as reasons for termination more frequently by profit sharing than by pension plans (2 out of 5 compared with 3 out of 10). No explanation is obvious. Unfortunately, the higher incidence among the profit-sharing plans usually involved no continuance of coverage in another plan.

The reasons for profit-sharing terminations tended to vary with plan size, but were not consistent with respect to plan age or general business activity. As shown in chart, 4, financial difficulties and business dissolutions were most prominent among relatively small plans. Financial difficulties accounted for 23 percent of the terminations involving fewer than 10 members. No significant decline in this proportion occurred until the plans reached a size of 250 members or more. However, financial difficulties were listed as the primary reason for terminating only 14 percent of the 250 to 500 member group. They declined to 9 and 5 percent in the 500 to 999 and 1,000 and over groups, respectively. Business dissolutions followed a

Op. cit., footnote 3.

smoother path of decline. They methodically declined from 29 percent of the plans with fewer than 10 members to 6 percent of those with 1,000 or more. In contrast, mergers and sales increased, though rather erratically, from 29 percent of the smallest group to over half of the groups with 250 members or more.

Pension experience was considerably different. 'The reasons for terininating a plan varied not only with plan size, but also with general business activity. For example, financial difficulty and business dissolution were most prominent when general

economic activity was relatively low. With respect to size, financial difficulty was most common in terminations involving small groups, organizational changes-business dissolution, sale, or merger-among the larger groups.

Extent of Benefit Losses

Participants in terminated profit-sharing plans do not lose any of their accrued benefit rights because they are invariably promised only their proportionate share of fund assets, rather than specific benefit amounts, and IRS requires full vesting of these interests. Although each participant's share of company contributions, forfeitures, and investment experience may be determined in various ways, earnings and years of service are usually taken into consideration. Credit units may be used for this purpose. For example, one or more credit units might be acquired for each hundred dollars of compensation and for each consecutive year of employment. All credit units are added together. Each participant's share of the funds is equal to his proportion of the total credit units. In contributory plans, allocations may, at least in part, be related to the amounts contributed by the employees.

The preservation of accrued benefit rights, however, does not safeguard participants from being affected adversely by plan termination. Although accrued benefit rights are preserved, poor investment may sharply reduce their value. This experience is especially likely if the plan holds the employer's own securities and if it terminates because of financial difficulties. Moreover, the employees cannot earn additional benefits for future employment unless their coverage is continued in another plan.

Many terminations during the period studied occurred without any provision for the continuance of worker coverage. Although this information was only obtained for mergers and sales, it is unlikely that more than a third of the quarter of a million participants in terminations were assured of coverage in another plan.

Most retirement plan terminations involve pension and profit-sharing plans. Internal Revenue Service records show, however, that during the years 1955-65 126 thrift and 29 stock bonus retirement plans were also closed out.' These 155 plans covered approximately 7,400 employees at the time of termination. In other words, the discontinuance of such plans affected only 673 employees a year, on the average.

A strong, though erratic, upward trend is noticeable in the number of plan deaths: two-thirds of the plans succumbed during the latter half of the 11-year period. However, this experience is not readily translated into meaningful rates of termination. Rates of closure cannot be determined for thrift plans, because we do not know how many are in existence. Rates for stock bonus plans can be figured, but they change erratically from year to year, apparently reflecting the extremely small number of stock bonus plans more than any fundamental change in their rate of termination,

The effect that general business conditions have had on plan mortality is partially obscured by the pattern of marked growth and random movements. Cyclical variations are evident, however. For example, the number of thrift plan terminations rose in 1961, a year of relatively low economic activity, and fell in the following year of recovery. The largest number occurred in 1963, a year of high activity. This pattern parallels pension experience.

Despite their limited numbers, terminated thrift and stock bonus plans exhibit characteristics similar to those of terminated pension and profit-sharing plans. Mergers and sales, financial difficulties, and business dissolutions were the most prevalent reasons for termination, regardless of the type of plan. Mergers and sales accounted for 3 out of 10 thrift plan terminations and 4 out of 10 stock bonus terininations. The higher incidence among the latter reflects a higher proportion of terminations without continuance of coverage.

Financial difficulties were cited more frequently by pension plans (1 out of 4) than by the other types (1 out of 5 or less). This is consistent with the nature of their respective contributory requirements. Pension requirements vary the least with

the employer's financial condition, because they alone cannot be linked to profits. Business dissolutions have affected the terminations of the various types of plans quite differently, with no obvious explanation.

Youth and small size were also common to all types of plans, but the stock bonus pattern differed from that of the other types. For example, the most prevalent age for stock bonus plans was 6 years, compared with 2 or 3 years for the others, although their median ages were almost the same (5 years for profit-sharing plans, 6 years for the others). The size of the median stock bonus plan was at least double that of the others (48 participants versus 13 to 23). This is consistent with the tendency of new stock bonus plans to be larger than new plans of the other types.

Benefit commitments of thrift and stock bonus plans are generally similar to those of profit-sharing plans. The extent to which benefit expectations are lost is dependent on contingencies such as poor investment experience and failure to continue coverage in another plan, rather than failure to fully fund accrued benefit rights. The value of a participant's benefits are particularly susceptible to a drastic decline whenever financial difficulties close plans heavily invested in the employer's own securities. Moreover, a large proportion of the employees participating in these plans, as in pension and profit-sharing ones, were not covered by successor plans.

As with the other plans included in this study, the thrift and stock bonus plans were qualified for favorable tax treatment under Sec. 401 of the Internal Revenue Code. Although the employer's contributions to a qualified stock bonus plan are not necessarily contingent on profits, the plan must provide benefits similar to those of profit-sharing plans. They are distributable in the employer's stock. The Code specifically mentions stock bonus plans, but not thrift plans Thrift plans must qualify as either profit-sharing or money purchase pension plans. Such plans invariably are contributory under either approach (profitsharing has generally been used). Employees who wish to particl pate might, for example, contribute from 2 to 5 percent of their pay. The employer typically matches or contributes some percentage of the employee's contribution, but numerous variations are possible.

10 The number of qualified stock bonus plans ranged from about a dozen in 1955 to around 173 in 1965.

11 Such investments are seldom an important part of pension portfolios.