As part of our ongoing partnership agreement series, in this article, we discuss how accounting firms can address retirement in firm partnership agreements.
Note: References to “partnership agreements” in this article refer to traditional partnership agreements, as well as shareholder agreements and LLC operating agreements. Similarly, when we refer to a “partner” in this article, this also applies to a shareholder of a corporation and a member of a limited liability company.
Most accounting firms provide for mandatory retirement in their partnership agreements. As a general rule, the retirement age is typically between the ages of 62-70 and it seems that the larger a firm is, the younger the mandatory retirement age is. Age 65 remains the most common mandatory retirement age.
Most partnership agreements allow for early retirement starting at age 55-60 if the partner has a specified number of years of service as a partner (e.g., 15 years). That said, early retirement is often discussed but is rarely used. If a partner does choose to proceed with an early retirement option, the partnership agreement should include a substantial notice period for early retirement—probably two years—to allow for the proper transition of clients and firm responsibilities.
Importance of Transition Plan
A transition plan is critical to ensuring that the firm retains the clients and other skills and abilities of the retiring partner so the partnership agreement should require all retirees to have a transition plan in place. The transition plan will be developed by the retiring partner in consultation with, and with the approval of, the managing partner or executive committee, or their respective designee.
Penalties for Failing to Provide Adequate Notice or Prepare a Transition Plan
It is common for the partnership agreement to levy penalties if a retiring partner fails to give the requisite notice or fails to prepare and adhere to a transition plan. We recommend that the firm’s executive committee have reasonable authority to reduce retirement payouts in the event of failure to adhere to these requirements. For instance, we drafted a partnership agreement granting the executive committee authority to reduce a retiree partner’s payments by up to 25% for failure to give the requisite notice or failure to adhere to the transition plan.
Retirement benefits typically have a vesting period, often times over a 15-20-year period. Some firms give partial or full credit for years as an income partner, and merged-in partners generally will be given credit for the period of time they were a partner at their old firm. Death and disability usually should not accelerate vesting, although in some firms they do.
The retirement payment payout period is typically 10 years, with the aggregate amount payable to retired partners each year capped at some portion of the annual revenue or net income of the firm (for example, 4% of the revenue of the firm). This ensures that the firm continues as a financially healthy organization while it is paying out its retired partners. Sometimes, founding partners have more favorable terms for their retirement payouts. Retirement payouts typically do not accrue interest, although this is not universal.
Many firms obtain life insurance on their partners to fund some or all of the buy-out payments. Partnership agreements usually include provisions regarding whether the partner has the right to take their insurance after retirement, but most firms do not allow for this.
When Partners Work After Retirement
Many partners want to work after they “retire.” Essentially, they give up their equity and become employees of the firm. Our recommendation is to have year-to-year contracts in these situations to manage expectations. Typically, retired equity partners are paid based on their personal productivity and whether they bring in new clients.
Other Key Components of a Partnership Agreement
Retirement is just one of the key components to be addressed in the partnership agreement. Other important aspects include governance and restrictive covenants. We address these and other partnership agreement components in this article.