For Top Executives, Richer Retirement Plans
With traditional pensions disappearing, tax rates and the future of Social Security in flux and even well-known businesses facing financial trouble, many workers are worried that their company retirement plans will not provide enough income.
But for the upper tier of executives, these trends could actually lead to richer corporate perks as management moves to compensate for the uncertainties.
Companies are rethinking their special programs of executive retirement benefits by expanding the eligibility pool, adding investment choices, increasing their corporate contributions and even designing entirely new structures — all in an effort to keep top executives happy.
“I see a change in the marketplace,” said Maggie Mitchell, a vice president of ING’s American insurance unit, which sells some of the new products for these executive plans. “People are looking for safer, tax-advantaged retirement income.”
The 1974 Employee Retirement Income Security Act, or Erisa, the basic federal pension law, limits the amount of money employees can set aside in a standard tax-deferred retirement plan, like a 401(k), using a formula adjusted each year for inflation.
The original idea was to spread the benefits somewhat equally and prevent the plans from favoring higher-ranking managers. But over time, as executives wanted to save more, companies added supplementary plans, generally known as nonqualified deferred compensation.
“For an executive, it’s to create a kind of super-retirement plan, because traditional retirement plans might not allow them to put away enough replacement income,” said Ross Levin, president of Accredited Investors, a wealth management firm based in Edina, Minn., whose clients’ minimum account size is $2 million. “And companies might do it to tether an executive to the company.”
Reliable statistics are scarce, but experts say these benefits are popular among large companies: they were offered at nearly 94 percent of the 300 companies in a Prudential Retirement survey released in May. The range of people covered in a company’s upper echelons varies, but typically participants must earn at least $150,000 a year.
These supplemental plans may look like their Erisa counterparts, with similar tax breaks and investment choices, and often the same matching contributions from the company. In some ways these might actually seem better because executives can squirrel away an unlimited amount (depending on corporate policy) and set their own dates for withdrawing the money, even before retirement. However, the plans have two serious flaws, both of which have been magnified by recent events.
The biggest problem is that if the business goes bankrupt, creditors can take all the money, even the executive’s own contributions. That is because by law, they are considered company assets. That risk hit home in the 2008-9 financial crisis, as seemingly solid names like the Borders Group, Lehman Brothers and Circuit City disappeared. Mr. Levin said that two of his clients lost several hundred thousand dollars each in deferred compensation in the last five years because their companies went bankrupt.
The second big weakness is that “there really isn’t much you can do today to get your money once the company is in bad straits,” said Frank Nessel, a senior Erisa consultant at the Vanguard Group.
Once an executive selects a withdrawal date, it is almost impossible to retrieve the money sooner. These plans lack the loan and hardship provisions of most 401(k)’s, and amendments to the tax code in 2004 reduced most of the limited flexibility executives used to have.
On the other hand, the bankruptcy risk gives executives a real stake in the company’s long-term survival, which fits with the growing trend to tie executive compensation to corporate performance.
The plans are also susceptible to uncertainty over the tax code. Many financial advisers expect taxes on their superrich clients to rise next year, through the expiration of the Bush-era tax cuts or in another way. In theory, higher tax rates in the future should make these plans less desirable, because participants are basically delaying paying taxes until they withdraw the assets. For that reason, Mr. Levin suggests that clients contribute only half as much as they did previously.
Other experts, however, say there are too many uncertainties to issue such blanket recommendations. If an executive’s income is significantly less in retirement, or he or she moves to a low-tax state from a high-tax one, the tax bill might still be smaller in the future than today, even if rates go up. High and compounded investment returns could also outpace tax increases.
The recession, the increase in bankruptcies, the reduced withdrawal flexibility and the uncertainty over taxes have prompted the financial services industry to come up with new ways to make the executive plans attractive.
The newest Prudential survey showed a small but clear trend in that direction. For instance, during the recession, about one-fifth of the businesses polled had reduced or eliminated their corporate matching contribution to nonqualified plans, just as they did with their 401(k)’s. This year, however, only 5.4 percent cut back, and a handful even expected to start or enhance a match. A further 6 percent said they would add more investment choices.
Sheryl Craun, senior vice president of operations in Fidelity Investments’ retirement plan business, said that about 5 percent of clients were adding investment options. The most popular is a self-directed brokerage account, which allows executives almost unlimited choices.
Ms. Craun has also noticed that lower-level managers, even those earning just $75,000, are now allowed in. “I think companies are becoming more loose, because they’re using this as part of their retention program,” she said. Still, businesses cannot spread the benefit too widely, or they risk losing the nonqualified status and all its privileges.
Employers are trying harder to persuade executives to participate and to invest more, using personalized meetings and online planning tools, said George Castineiras, the senior vice president who heads Prudential’s total retirement solutions business.
And financial experts are looking for solutions to the bankruptcy problem. These solutions usually involve creating asset pools that contain real cash in the executive’s name. This protects the money from corporate creditors but raises new tax problems.
A few businesses, particularly in industries like tobacco and technology, are taking a second look at so-called secular trusts, said Robert Barbetti, an executive compensation specialist at J. P. Morgan Private Bank. The assets do not have the full tax deferral of a standard nonqualified plan, Mr. Barbetti said, but the employer typically adds enough money to the trust — “grosses up” the executive, as he put it — to cover the extra liability.
The catch, he said, is this: “Once you start grossing up for the executives, that catches the shareholders’ attention.” And companies like Citigroup, whose shareholders this spring voted down a $15 million pay package for the chief executive, Vikram S. Pandit, have enough trouble on that score.
ING is marketing what it calls a Bonus 162 plan, based on section 162(a) of the tax code, which allows companies to deduct an unspecified amount of “ordinary and necessary” business expenses. Despite the name, executives can contribute any after-tax income, not just bonuses. If they invest the money in life insurance products, Ms. Mitchell said, the earnings are tax-free, although executives must pay taxes up front on their initial contributions.
With his own executive compensation plan, Mr. Barbetti said he had decided to extend his withdrawal date by two years, to 2024. (He would not reveal the size of his account.) “Because of not knowing where the tax rates are going to go,” he said, “I wanted to make sure I deferred long enough so that the interest-rate compounding would equal the taxes.