Page 323 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

Chapter 6. Employee Benefits and Perquisites 309

offer, the executive may request a lump-sum payment. The lump sum can then go toward
purchase of an annuity from an insurance company, beginning immediately, or be rolled over
tax free into an IRA.

Late Retirement. The definition of late retirement is a retirement at any point in time past
“normal” retirement. Since, with the exception of certain senior executives, it is no longer
legally permissible to require a person to retire when reaching normal retirement age, plans
will continue to accrue benefits until the individual leaves as a late retiree. While the earn-
ings and service credit will add to benefits, there is typically no additional percentage for late
retirement to complement the discount for an early retirement. Because of mortality factors,
late retirements may cost defined-benefit plans less than normal retirements.
Vesting. When individuals have earned the right to receive benefits because of the years
of service, they are said to be vested. Even though an individual may not be eligible for
retirement (normal, early, or late), the person may have earned a benefit. Tax-qualified
plans require that an employee’s right to receive benefits (i.e., become vested) occurs after
a prescribed period of time. This requirement can be met in one of two ways: the simplest
is full benefits accrued after five years of service (but nothing prior). This all-or-nothing
type is called cliff vesting. The other way in which benefits can be vested is by using a
“graduated” schedule that begins vesting 20 percent after completing three years of
service with an additional 20 percent every year thereafter, reaching 100 percent after
seven years. There are exceptions for multiemployer and top-heavy plans. Once an
employee works 1,000 hours in a year, the individual is considered to have one year’s
service credit. Vested benefits may be subjected to a discount schedule described in the
retirement age section.
Definition of Pay

Retirement plans define earnings as salary paid during the period of employment. Many
companies, if not most, also include short-term incentive pay. This was not true years ago,
but with incentive pay taking on greater prominence, it became necessary; otherwise, the
pension would be too small in relation to final pay. Including short-term incentives results in
variable earnings year to year. This becomes important when determining the period of final
years for defined-benefit plans, as will be discussed later in the chapter.
Long-term incentives are rarely included in either defined-benefit or defined-contribution
plans. If they were included, pension benefits would likely be significantly greater than final
annual earnings.
Postretirement Adjustments

Companies sometimes increase the annuities of retirees if there has been a period of signifi-
cant inflation since the date of their retirement. Typically, the adjustment is some fraction of
the inflation increase similar to inflation-indexed social security benefits. Retirees may also
receive a postretirement increase in their annuities from a career-earnings plan if the plan were
“updated” (described later in this chapter), raising the retirement amount. For example,
a person whose career-earnings average was updated from $200,000 to $250,000 would receive
a 20 percent increase in the monthly annuity. This increase would come from two sources.
The qualified plan would pay the maximum allowable, and the nonqualified, supplemental
plan would make up the difference.