chapter 19: Executive Retirement Arrangements

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chapter 19 Executive Retirement Arrangements

• Creation date unknown (probably precedes the
  last version of the textbook for which I was a
  co-author though)

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objectives most frequently set forth for
implementing an executive retirement arrangement

• Providing retirement income in excess of that
  permitted from qualified retirement plans under
  the Employee Retirement Income Security Act
  (ERISA) because of the IRC Section 415
  limitations
• Recruiting an executive in mid- or late-career
  whose combined pension, from current and prior
  employers, falls short of reasonable retirement
  income objectives, since only his or her current
  period of service reflects the compensation
  levels he or she achieves before retiring
• Establishing an additional element of executive
  compensation to attract and motivate qualified
  executives
• Discouraging certain executives from terminating
  employment prior to qualifying for early
  retirement benefits
• Encouraging the early retirement of some
  executives by providing unreduced benefits at an
  earlier age

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the typical executive retirement plan is unfunded

• to avoid ERISA's benefit and contribution limits
  and compliance requirements and unfavorable
  income tax treatment
• employee is an unsecured creditor of the employer
  and has no rights to any specific asset even
  though the employer might use a funding vehicle
  to set aside assets to meet its future obligation
  under the agreement

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supplemental executive retirement arrangement
vs. a deferred compensation agreement

• If the plan really provides additional benefits,
  it is referred to as a SERP
• If compensation already earned by the employee is
  merely deferred primarily to save income taxes,
  the arrangement is referred to as a deferred
  compensation agreement

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eligibility requirements typically used under a
SERP

• The most frequently used criteria to establish
  eligibility for participation is position
• Some organizations determine eligibility by
  whether the executive is eligible for the
  company's incentive compensation program
• No constraints are imposed by the IRC or ERISA on
  the selection of eligibility criteria
• the SERP could become a retirement plan under
  ERISA and subject to all its requirements.
• if the group covered is so large that it extends
  beyond "a select group of management or highly
  compensated employees"

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employers may purchase insurance contracts

• If the employee were the owner, he or she would
  be considered to be in constructive receipt of
  the benefits and incur a current tax liability
• If the employer is both the policyholder and
  the beneficiary, the income is not currently
  taxable to the employee.
• although premiums may not be deducted from the
  employer's taxable income, investment earnings
  are not currently taxable to the employer and
  policy dividends and death benefits are not
  taxable when received

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lump sum options

• rarely made available to the executive
• no tax advantages exist and the entire amount
  would be treated as taxable income in one year
• the company would lose control over the
  executive's ability to enter into competitive
  employment after retirement

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vesting

• if an executive terminates employment prior to
  the earliest retirement age possible, it is not
  customary to provide a vested interest in an
  unfunded SERP
• an exception might be when a major objective of
  the SERP is to assist in mid- or late-career
  recruiting

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potential consequences of funding a SERP

• the plan would lose its exemption from ERISA
  compliance
• tax considerations applicable to a funded plan
• company contributions to a funded plan would not
  be deductible unless and until the executive
  achieves a nonforfeitable interest
• as soon as the executive's rights become
  nonforfeitable, he or she could be considered in
  constructive receipt of the value of the
  then-accrued benefit
• even if the funds were not then available to the
  executive
• all future company contributions could be taxable
  to the executive as they are made
• ERISA requires vested interests be created under
  funded plans
• even if not tax qualified

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"rabbi trust"

• company creates an irrevocable trust for the
  benefit of an executive or a group of
  participating executives
• terms of the trust limit the use of the assets to
  providing benefits for the participating
  executives
• trust assets cannot be used by current or future
  management
• but remain subject to the claims of creditors in
  the event of the firm's insolvency

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corporate-owned life insurance

• the employer is the owner and beneficiary of a
  life insurance contract
• designed to accumulate sufficient cash values to
  pay the benefits promised the executive
• life insurance policy must be carried as a
  corporate asset
• provides only very limited benefit security for
  the executive since cash values and death
  benefits are within the employer's control

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doctrines of constructive receipt of income and
receipt of a taxable economic benefit

• economic benefit states that if a taxpayer is
  receiving a current benefit, he or she should be
  taxed currently on the value of that benefit
• constructive receipt states that if a taxpayer
  could receive income at any time but elects to
  receive it later, he or she is still taxed
  currently
• Revenue Ruling 60-31 states that deferred
  compensation is not taxable before actual receipt
  whether it is forfeitable or nonforfeitable,
  provided
• the deferral is agreed to before the compensation
  is earned,
• the deferral amount is not unconditionally placed
  in trust or in escrow for the benefit of the
  employee, and
• the promise to pay the deferred compensation is
  merely a contractual obligation not evidenced by
  notes or secured in any other manner
• while certain assets may be earmarked and
  informally set aside to give some assurance that
  benefits will be paid, there must be no formal
  funding instrument and the executive must not
  have current access to the benefits

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advantages of deferred compensation arrangements

• deal primarily with earnings deferral, usually to
  gain tax advantages, with retirement income as a
  secondary consideration
• Postponing the receipt of current income not only
  reduces executives' current taxable income, but
  puts them in receipt of the funds after
  retirement when they may be in a lower tax
  bracket
• Other reasons for deferring current income from
  both the executive's and the employer's
  viewpoints are
• (1) extending the executive's income beyond
  normal working years into retirement
• (2) spreading bonuses over a wider span of years
  
• (3) tying the executive to the employer by
  stipulating conditions on the receipt of deferred
  amounts and
• (4) adding to the executive's retirement income.