Page 105 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

Chapter 3. Current versus Deferred Compensation 91

$28,051 is worth $14,026 after taxes (assuming the entire amount is subject to a 50 per-
cent tax). This is $2,013, or 16.8 percent more than the after-tax value of $20,000 paid
out immediately and then invested at 7 percent (because the amount available for
investment was $10,000, not $20,000, since it was immediately subject to a 50 percent
tax). For 10 years’ deferral, as shown in Table 3-3, the posttax values increase to $19,672
and $14,836, respectively, for a $4,836 or 32.6 percent variance. This increase in
absolute and relative differences is also shown for 15 and 20 years.

$10,000 $20,000 Posttax Variance
Years Pretax Posttax Pretax Posttax Amount Percentage

5 $14,026 $12,013 $28,051 $14,026 $2,013 16.8
10 19,672 14,836 39,343 19,672 4,836 32.6

15 27,590 18,795 55,181 27,590 2,795 46.8
20 38,697 24,349 77,394 38,697 14,348 58.9

Table 3-3. Pre- and posttax comparisons—current vs. deferred with 7 percent interest

3. Deferrals can increase retirement income and thereby offset pension plan weaknesses,
especially for executives.
4. Deferred salary and incentives may be included as pensionable earnings for nonqualified
pension plans in year earned, thereby protecting the pension.
5. In accord with Revenue Rulings 68-99 and 72-25, it would appear that the employer can
fund the deferred compensation obligation without triggering an income liability to the
employee if the company owns all policy rights, including designation of beneficiary.
6. If the individual has significant preference income and/or ordinary income currently,
the marginal tax rate may be less at a subsequent date. However, the possibility of high-
er marginal rates in the future through new tax legislation is a high offsetting risk.
7. A nonqualified plan is not subject to ERISA funding requirements (but is probably
covered by the reporting requirements) as long as such benefits are in excess of defined
benefit or contribution plan limits, and/or deferral arrangements are limited to more
highly compensated individuals.
8. Generally, social security benefits are not affected by the amount of deferred payments
received. However, care should be taken in developing such arrangements because
payment (which permits the company to use the individual as a consultant) may be
regarded as wages for the purpose of reducing social security payments. This may be
only a short-term issue, however, as individuals aged 65 and over are permitted unlim-
ited earnings without reducing social security benefits, per the 2000 Senior Citizens,
Freedom to Work Act.
9. If amounts deferred are under risk of forfeiture for executives who leave the company
for reasons other than death, disability, or retirement, the individual’s inclination to join
another company may be retarded. However, under Section 409A of the Internal
Revenue Code, withdrawals are permitted for an “unforseeable emergency” this
“means a severe financial hardship to the participant resulting from an illness or acci-