Beyond Qualified Plans: Providing & Securing Retirement Benefits for Execs
Ben-Meyer, Saul, Management Review
Following the enactment of the Employee Retirement Income Security Act of 1974 (ERISA), qualified plans became the principal vehicles to provide retirement benefits to employees. Tax benefits that encourage use of qualified plans include:
* immediate deductibility of employer contributions;
* Tax-deferred accumulation of assets;
* No tax to employees until actual receipt of benefits; and
* Favorable tax treatment of certain types of distributions to employees.
Additionally, qualified plan assets are held in trust for the exclusive benefit of the employees and generally cannot be reached by creditors.
In exchange for these benefit$, Congress imposed numerous restrictions on qualified plans including non-discrimination requirements that limit the benefits that can be provided to highly compensated executives. In no fewer than 14 of the 16 years since ERISA was enacted, new legislation has progressively eroded the benefits available to executives under qualified plans. The budget deficit is expected to continue to contribute to these cutbacks.
As a result, there has been rapid movement toward non-qualified deferred compensation (NQDC) plans. A survey released by William M. Mercer Inc. last June found that 38 percent of 2,300 responding companies now sponsor NQDC plans.
NQDC plans offset the cutbacks in qualified plans and provide additional benefits to recruit and retain executives. Not surprisingly, NQDCs are not afforded the favorable tax treatment of qualified plans. The employer's deduction is deferred until the benefit is paid and the executive receives no special tax treatment. Nor is the executive provided with the same level of security since NQDC plans are generally unfunded and based merely on the employer's promise to pay.
As the source of executive retirement benefits shifts from qualified to NQDC plans, executives are focusing their attention on ensuring the payment of NQDC plan benefits when promised, regardless of the willingness or ability of the employer to pay. The following summarizes the most popular types of NQDC plans and the vehicles used to provide security to the executive.
EXCESS PLANS AND SERPS
An "excess plan" is a NQDC plan that provides benefits only in excess of the limits imposed on contributions and benefits under qualified plans by Section 415 of the Internal Revenue Code. The maximum annual benefit payable under a qualified defined benefit plan at the current time is approximately $82,000 for a retiree at age 62 and $41,000 for a retiree at age 55. These limits may be cut further if the executive has completed less than 10 years of plan participation. Limitations also are placed on annual contributions to defined contribution plans, such as profit sharing and 401 (k) plans.
A supplemental executive retirement plan (SERP) is a NQDC plan that also provides benefits in excess of limitations imposed by the Code but is not restricted to replacing benefits cut back under Section 415. A SERP can also provide additional benefits to executives, including:
* Benefits based upon compensation in excess of the $200,000 Code limit;
* Employee pre-tax deferrals in excess of the $7,000 Code limit (as indexed for inflation);
* Employee deferrals and employer matching contributions in excess of the amounts allowed under 401(k) plans;
* Benefits based upon an executive's total compensation, including deferred compensation, bonuses, severance pay and incentive pay excluded under the qualified plan;
* Replacement of benefits lost under a qualified plan due to a reduction under the Code of the level of permitted disparity reflecting the lower Social Security benefits provided to executives as a percentage of compensation;
* An unreduced early retirement benefit or an additional early retirement supplement as part of an early retirement incentive program;
* Replacing benefits lost by an executive hired away from another employer;
* Past service credit to an executive in excess of the five-year safe harbor under recently proposed regulations;
* Supplemental disability and death benefits to selected executives; and
* Replacing benefits lost upon substitution of a defined benefit plan with a defined contribution plan. …