Page 315 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

Chapter 6. Employee Benefits and Perquisites 301

Paying for the Plan
Pension plans are company-pay-all (noncontributory), employee-pay-all (contributory), or a
combination of the two. Typically, defined-benefit plans are paid totally by the company,
whereas defined-contribution plans could be financed any of the three ways.
The IRS has generally held that mandatory contributions by employees to defined-
benefit or defined-contribution plans in total that do not exceed 6 percent of pay will not be
discriminatory. Voluntary contributions in total should not exceed 10 percent of pay.
Therefore, assuming both maximums were employed, employees could contribute up to
16 percent of pay. Though numbers in excess of these might be acceptable to the IRS, the
burden of proof would be upon the company to demonstrate that the contributions were not
so burdensome as to enable only highly compensated employees to take full advantage of
the plan(s).

Integration with Social Security
Recognizing that social security benefits are of significantly greater value to lower-paid than
higher-paid employees, companies are permitted to take this into consideration when design-
ing their tax-qualified defined-benefit and defined-contribution plans. The Tax Reform Act
of 1986, along with supporting IRS regulations and interpretations, specifies the manner in
which these benefits may be “integrated” with social security and not discriminate in favor
of highly compensated individuals. Plans must have an integration threshold, permitted
disparity, and the two-for-one restriction.
The integration threshold is the compensation level that separates the base from higher
benefit levels or contributions. The permitted disparity sets the maximum difference for
defined benefits (accrual rate) and defined contributions (contribution rate) between lower
and higher paid. And the two-for-one restriction prevents designing plans where lower-paid
employees receive no benefit, since the benefits above the integration level cannot be more
than twice the amount of those below that level.
Additionally, defined-benefit plans are permitted excess benefits that are the lesser of the
base pay percentage or 0.75 percent (per year of service) of compensation above the integration
level. Thus, a plan crediting nothing below the integration level could provide no benefits
above the integration level. Conversely, if a plan permitted a 1.0 percent base pay percentage,
it could not provide a benefit greater than 1.75 percent above the integration level.
For defined-benefit plans, the allowable difference cannot exceed 5.7 percent above the
integration level. A 6 percent rate for pay below the integration level would allow 11.7 per-
cent but not higher (the 5.7 percent factor).
While qualified plans cannot be designed to discriminate in favor of executives, too often
the plans do not take full advantage of permissible provisions and in fact discriminate against
highly paid individuals. A classic example is when the defined-benefit plan is not integrated
with social security. The result is that lower-paid employees receive a higher dollar benefit
than would be permissible and higher-paid employees receive a lower one.
How Big a Pension?

There are two basic approaches in determining the amount of pension to be provided:
how much is needed and what is competitive? Both factors need to be evaluated and some