Download - “START" - Save Today and Retire Tomorrow Solutions to Enhance Retirement Security for Executives Erik Pienkos Senior Manager Benefits Consulting Practice

“START" - Save Today and Retire Tomorrow

Solutions to Enhance Retirement Securityfor Executives

Erik PienkosSenior ManagerBenefits Consulting [email protected]

© Grant Thornton LLP. All rights reserved.

Background

• Survey data indicates that the typical level of retirement income for executives at age 65 is a minimum of 50% of final average salary (FAS):– A significant percentage of companies provide for higher levels of

retirement income (60% of FAS or higher)• Most companies use a final 5-year measurement period for benefit

determination purposes:– A significant percentage use a final 3-year measurement period

• A "career" threshold for analyzing retirement benefits for rank-and-file employees tends to be longer (generally 30 or more years):– Many companies design executive retirement programs to provide

the targeted level of retirement income using a shorter service threshold (generally 15 to 20 years or less)


Background (cont'd)

• Qualified retirement plans (pension plans, 401(k) plans, etc.) are generally not designed to maximize benefits for executives:– Fewer companies maintain pension plans today– Low participation by non-highly compensated employees (NHCEs)

will impact 401(k) contributions by executives– Deferrals capped at $16,500 in 2009/2010– Testing failures result in refunds to executives

• There are many reasons why companies examine various alternatives to provide greater levels of retirement income for executives:– IRS limits on qualified retirement plan benefits– Need to provide incentives to attract, retain and motivate key

personnel– Desire to provide targeted level of retirement income for executives


Potential Plan Design Solutions

• Dual (mirror) plan design• Automatic enrollment• Safe harbor plan designs:

– Traditional plan– New automatic enrollment plan (effective 2008)

• Roth 401(k) feature• Cross-tested "comparability" plans• Multiple plan design• Nonqualified retirement plans


Dual (Mirror) Plan Design

• Create a separate mirror 401(k) plan similar to the original plan• Move low participation employees (non-highly compensated employees

only) into the mirror plan:– Do not cover any highly compensated employees (HCEs) in the

mirror plan• Mirror plan and original plan must separately pass plan coverage test:

– Will need to monitor plan coverage levels carefully– Use of nondiscriminatory classification test provides flexibility– Depending upon the mix of NHCEs and HCEs, percentage of

NHCEs that can be moved into the mirror plan can be significant• Original plan should have significantly better test results:

– Greater pre-tax deferrals will be allowed for HCEs– Will result in higher levels of accumulation for executives in the plan


Automatic Enrollment

• Consider use of automatic enrollment feature to increase NHCE participation rates:– Will help improve nondiscrimination test results (fewer zeros in test)– HCEs will benefit but will increase company's matching contribution

commitment – Can limit automatic enrollment feature to new hires only or can also

have it cover current eligible employees who are not making pre-tax deferrals

• Need to consider administrative implications of automatic enrollment:– Employees can opt out once they are automatically enrolled– Potentially creates lots of small recordkeeping accounts, so plan

administration costs may increase


Safe Harbor Plan Designs

• Traditional safe harbor plan:– Level of company contributions– Vesting

• New automatic enrollment safe harbor plan design (2008):– Automatic enrollment levels– Level of company contributions– Vesting

• Safe harbor plan design will maximize the ability of executives and other HCEs to make pre-tax deferrals:– No special nondiscrimination testing for the plan– Automatic enrollment safe harbor will help retirement accumulations

for NHCEs (but will also increase contribution costs and plan administration costs for employer)


Roth 401(k) Feature

• 401(k) plans can allow employees to designate all (or portion) of elective deferrals as after-tax Roth deposits:– Generally treated the same way as pre-tax deferrals:

• Same IRS limit applies ($16,500 in 2009/2010)• No double dipping with both pre-tax deferrals and Roth after-tax

contributions• Treated as elective deferrals under ADP test

– Earnings are not currently taxed to employees– Distributions are not taxed if certain requirements met

• Better than employee pre-tax contributions if income tax rates rise in future years:– Serves as hedge against future income tax increases


Cross-tested "Comparability" Plans

• Allows for enhanced contribution levels for a select group of management:– Takes advantage of qualified plan nondiscrimination rules to design

plans that can provide significantly higher annual benefits– Test defined contribution plan (401(k) plan or profit sharing plan)

like a defined benefit pension plan– Annual allocation based upon "class" (such as job description, etc.) – May eliminate or reduce the need for nonqualified plan:

• Eliminates a potential 409A compliance issue• Result: Targeted executives can receive substantial annual

contributions at or near the IRS annual plan limit ($49,000 in 2009/2010)


Multiple Plan Design

• Implement a two-plan structure that targets older executives:– Defined benefit pension plan will cover certain HCEs (generally

older ones) and limited number of NHCEs (generally younger ones)– Remainder of eligible employees will stay in the 401(k) plan

• Will need to monitor plan coverage and, more importantly, minimum participation requirements so that there is sufficient NHCE coverage in the defined benefit pension plan:– Number of NHCEs in pension plan will depend upon size of eligible

workforce and mix of HCEs and NHCEs– Minimizes opportunity to only cover executives in the pension plan

• Goal is to maximize the employer contributions in the pension plan for the older HCEs:– Will generally mean that older executives receive employer

contributions in excess of amounts permitted under the 401(k) plan rules


Nonqualified Retirement Plans

• Complete employer discretion as to plan design, covered group of executives, level of benefits, key features, etc.

• Employees generally not taxed until amounts are received:– Employer takes income tax deduction as the same time

• Can provide benefits in excess of qualified plan limitations and can base benefits on compensation in excess of IRS pay cap for qualified plans ($245,000 in 2009/2010):– Many nonqualified plans are "linked" with qualified plans

• Benefits generally not funded so executives are unsecured creditors• Need to make sure that plans comply with new deferred compensation

rules under IRC 409A:– Generally should not be a compliance problem– In event of noncompliance, 20% excise tax assessed on executives


Example – How START can work

• ABC maintains a “garden variety” 401(k) plan for all employees– On track to fail ADP/ACP testing for the third year in a row

• Executives and other highly-compensated employees will be getting refunds of $3-4K each

• Employee communication efforts have not led to increased NHCE deferrals

– One solution – go with safe harbor design coupled with class allocation profit sharing feature

• Executives grouped into classes (perhaps top execs in Class A and other key management in Class B)

• 3% safe harbor contribution provided to NHCEs to allow plan to escape ADP/ACP testing

• Additional, discretionary annual profit sharing contribution can be made to NHCEs to allow for larger exec contributions

– Class A execs targeted to max out at $49K total contribution – Class B members targeted for 12% of pay contribution


Evaluation Process

• Review current qualified plan design and projected level of benefits for executives under various assumptions at different retirement ages

• Identify employer's goals for executive benefits, including cost constraints

• Analyze various plan designs (both qualified plan and nonqualified plan):– Level of benefits– Costs (including any incremental qualified plan costs)– Nondiscrimination test results (if required based on plan design)

• Recommend plan design(s) that meet employer's goals• Agree on final plan design• Implement enhanced plan(s)• Communicate with affected individuals

Supplemental Unemployment Benefit (“SUB”) Plan

Providing Tax-Efficient Severance Benefits


Overview of SUB Plan Idea

• SUB plan can be used to provide income to laid-off workers to supplement their state unemployment compensation benefits

• Severance payments from a SUB plan that are intended to supplement the receipt of state unemployment benefits are not considered "wages" for employment tax purposes


Overview of SUB Plan Idea (cont'd)

• The SUB Plan allows payment of periodic (not lump-sum) unemployment benefits free of FICA and FUTA

• Payments received by employees under a SUB Plan are likewise not subject to FICA withholding

• Payments made by the SUB Plan do not disqualify the employee from state unemployment compensation benefits


Key Requirements

• Benefits are paid only to unemployed former employees who are laid off (e.g., an involuntary separation from service)

• Employees are eligible to receive benefits under the SUB Plan only if they apply for and receive state unemployment benefits

• Amount of benefits payable is based upon the employee's state unemployment benefits and his/her rate of straight-time pay


Key Requirements (cont'd)

• Employees must receive benefits periodically (e.g., weekly or according to their frequency of pay when employed):– No benefits can be payable in a lump sum

• Company must monitor and track employee eligibility for state unemployment benefits:– SUB Plan payments must stop when employee

is re-employed


Timing

• Prospective application only:– Layoffs commenced – not viable; mid-stream

change difficult– Layoffs announced – need time to implement

strategy (minimum 1 to 2 months)


Impact on Company and Affected Former Employees

• Implementation of SUB Plan may result in significant tax savings to both company and its former employees:– Worker receives $5,000 in severance payments

periodically before re-employment– FICA tax savings alone are approximately $380

for both company and former employee (assumes FICA tax rate of 7.65%)


Welfare Benefit Trust Funding

• Can optionally fund the SUB Plan through a tax-exempt welfare benefit trust (IRC Section 501(c)(17))

• Use of trust may allow company to fund and deduct contributions to trust in year made and have trust earn income on assets free of taxation


Implementation Planning – Key Steps

• Determine severance plan parameters, eligibility requirements and other SUB Plan design and administration issues

• SUB Plan feasibility assessment:– Number of affected employees– Severance levels– Potential FICA tax savings– Trust funding strategy– Implementation and administration costs


Implementation Planning – Key Steps (cont'd)

• Develop template for plan document for drafting by legal counsel

• Prepare employee communication materials• Assess internal vs. external administration

capabilities• Coordinate ongoing administrative responsibilities:

– Monitor compliance with SUB Plan requirements so FICA tax savings are generated

Download - “START" - Save Today and Retire Tomorrow Solutions to Enhance Retirement Security for Executives Erik Pienkos Senior Manager Benefits Consulting Practice

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