cbupdateshead.jpg

The ERISA Strategist
 December, 1999  
The Care and Feeding of Executives

In today's environment where finding and keeping good management employees is ever more challenging, companies are increasingly searching for  alternative ways to gain a competitive advantage in attracting and retaining executives.  Companies should consider adopting one or more of the following three techniques to improve their compensation program and retention rates.

1. Non-Equity Based Plans

Salary and Bonus Deferral Plans

A select group of management employees ("Executives") could be permitted to defer a portion of their compensation (including their bonuses) until some specified date in the future.  This date is generally retirement. No taxes are paid on any amounts that the Executive defers.  The assumption is that when the payment is made, the terminated Executive will be in a lower tax bracket than he would be if he simply took the money as income in the year earned.  Other dates, such as the date a child is expected to attend college, could be selected.

Excess Benefit Plans

Excess Benefit Plans are designed to provide benefits to Executives whose qualified plan benefits (i.e., 401(k) and pension benefits) are cut back due to Tax Code restrictions. These plans generally take into account the following Tax Code limitations:

  • The limit on the amount of compensation that can be considered in computing benefits.
  • The limit on the maximum annual benefit.
  • The $10,000 limit on 401(k) contributions.
  • The non-discrimination limit on 401(k) and   matching contributions.

Supplemental Employee
Retirement Plans ("SERP")

This is a non-qualified plan designed to provide Executives with additional retirement income.  A company may decide that it wants its Executives to retire with a certain percentage of their pre-retirement income ("Replacement Ratio").  The SERP fills the gap between what is available from the Company's qualified plans, social security, IRA distributions and the Replacement Ratio.

Another type of SERP provides for an account that the company contributes to annually on behalf of the Executive.  Unlike a salary deferral plan, the Executive does not have a choice to receive this amount as compensation income.  Upon termination of employment, the Executive will be paid a lump sum or installments.  A vesting schedule could be implemented to encourage long-term service.

Funding of Salary and Bonus Deferral Plans, Excess Benefit Plans and SERPS.

Many companies establish rabbi trusts.  The company will either fund the rabbi trust  or establish book-entry accounts for each Executive which theoretically hold contributions ("Assets").  A rabbi trust is a trust that segregates the Assets from the other monies of the company.  A Trustee needs to be appointed.  This could be a bank or an employee who is not eligible for benefits under the deferred compensation arrangement.

The Assets held in a rabbi trust remain subject to the claims of the company's creditors.  Thus, in the event of a bankruptcy, the Assets could be used to satisfy the claims of creditors.

Companies also must decide what the rate of return is to be on the Assets.  The Assets could be credited with a theoretical interest rate or a stock market index could be used.

2. Insurance Products

Split-Dollar Life Insurance

Companies may choose to  purchase whole life insurance policies for select employees.  These policies allow the employee to borrow the cash value to use in their retirement years (or earlier) and, to the extent this value is untapped, to provide for a death benefit. 

Generally speaking, either the cost of the premium or the cash surrender value of the policy is retained by the company.

Bonus Life Insurance

Companies may also provide additional (bonus) life insurance for its employees.

3. Equity-Based Deferred Compensation Plans

Stock Purchase Plans

Stock Purchase Plans allow employees to purchase stock at its fair market value.  Restrictions on the sale of the stock can be established.

Non-Qualified Stock Options

Non-Qualified Stock Options allow employees to purchase stock at a predetermined price, which hopefully is lower than the stock's fair market value when the option becomes exercisable.  Restrictions on the sale of the stock can be established.

Stock Appreciation Rights/Phantom Stock

Stock Appreciation Rights/Phantom Stock programs provide compensation to an employee based on the appreciation of the value of the stock, without providing an equity interest to the employee.  These programs work like Stock Option Plans, except that the employee receives the incremental gain in value without actually owning the stock.

Stock Performance Awards

Stock Performance Awards are similar to a non-qualified stock option plan.  However, the exercise price is set higher than the fair market value of the stock at the date the Performance Award is granted.  The options vest when the value of the shares equals the option price.  Vesting could also be made contingent on achieving individual performance goals.

As you assess 1999 results and plan for a new millennium  year, it is a good time to review your company's strategy for the "care and feeding of your executives" in order to implement any new employee attraction or retention programs.  We would be happy to perform a compensation package review and report our recommendations to you.  For information regarding a  compensation review, call Ira Friedrich or Carl Cannon at (404) 525-8622, Dana Thrasher at (205) 252-9321, or Rob Floyd at (703) 527-0900.

 

The information in this publication is for the purpose of informing and educating our clients about various aspects of the law and is not intended to be used as legal advice.