Page 324 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

310 The Complete Guide to Executive Compensation

During times of high inflation, executives are likely to defer plans for early retirement,
thereby building up additional years of credit for pension payments. This is especially true
when a company does not periodically improve the annuities of retired employees. Since
social security payments represent a greater portion of the pension of lower-paid employees,
such individuals are less affected by a company’s unwillingness to improve annuities of
retirees than the executive whose major portion of pension is from the company plan, not
social security.

Defined-Benefit Plans

Defined-benefit plans fall into three categories. A career-service plan is typically limited to
hourly paid workers and negotiated by unions. Benefits accrue with length of service. For
example, the benefit may equal $20 a month for every year of service. A career-earnings plan
calculates benefits based on total earnings during employment. For example, the benefit may
equal 1.4 percent per year for every $1,000 in earnings over the full span of employment. A
final-pay plan is more complex than the other two, incorporating both earnings and years of
service. For example, the benefit may equal 1 percent per year for every $1,000 of average
earned income multiplied by all years of service with the company. (Average earned income
might be defined as the average of the highest-paid 5 of the last 10 years of employment prior
to retirement.
Section 415(b) of the IRC limits the annual pension from a qualified defined-benefit
pension plan to the lesser of $160,000 or 100 percent of the participant’s average compensa-
tion for the highest-paid three years. The dollar limit is subject to adjustment to the IRC.
The IRC also places some restrictions on how the benefits may be funded. More specif-
ically, Section 404 of the IRC prohibits investment of more than 10 percent of the fair
market value of the plan’s assets in the company’s stock. This restriction applies at time of
contribution. Thus it would seem that should the company’s stock outperform the rest of the
portfolio, the plan’s trustee may choose, but would not be obligated, to sell off the apprecia-
tion. Conversely, it would seem that if the portfolio outperforms the company stock and its
value drops below 10 percent, the trustee may choose, but is not obligated, to purchase
sufficient shares to restore its 10 percent position.
Furthermore, the IRC prohibits increasing plan benefits as a result of terminated employee
nonvested forfeitures. The amount must be used to reduce employer contributions.
Career-Service Plan. Since by definition the annuity formula of a career-service plan is
based solely on years of service, such plans are of no interest to highly paid executives. By
excluding pay in the formula, they take on a very egalitarian appearance and not too surpris-
ingly are typically found in group agreements such as might be seen in third-party negotiated
contracts.
Career-Earnings Plan. Career-earnings plans were very common years ago, but lost their
popularity during periods of inflation and significant pay increases. Therefore, most of the
career-earnings plans still remaining effect “updates,” bringing earlier pay years up to more
recent levels. In so doing, they take on an appearance similar to final-pay plans, although
without the heavy cost impact of future service liability—thereby making them very attrac-
tive to financial people. For example, every several years the company might update all earn-
ings prior to five years ago to the five-year-ago figure. For an employee with 20 years of serv-
ice now earning $100,000, this would mean updating the first 15 years of pay to that earned