Page 330 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

316 The Complete Guide to Executive Compensation

• This form of integration does not make it clear to employees that the company’s real
objective is to supplement social security up to a certain overall benefit level.
• Although an excess plan can be structured to take into consideration adjustments in
the wage base, it offers no built-in cost-containing features for legislated social secu-
rity changes. Accordingly, major decision changes in the pension formula could be
necessary each time a new social security law is passed.
• It is not logical to relate benefits in a retirement plan to movements in the social secu-
rity taxable wage base, particularly when the objective is to integrate benefits from
both sources to provide an appropriate amount of total retirement income.
Offset Integration Method. The second basic approach, the offset integration method, is
more common with final-pay than career-earnings plans. It employees one percentage for all
earnings and then another percentage (equal to or lower than the first) to the social security
benefit. The maximum disparity between the numbers is the lesser of 0.75 percent or 50 per-
cent of the percentage above the integration level. To illustrate, let’s use the following formu-
la: 1.5 percent of average earnings 1.25 percent of primary social security benefits. The
resulting amount will be multiplied by the years of creditable service. Assume that average
earnings are equal to the highest consecutive five-year average (which in our earlier example
was $86,400) and that primary social security equals $24,000. The annual annuity is therefore
$19,920: i.e., [1.5% ($86,400) 1.25% ($24,000)] 20 years.
The rationale for this form of integration is that the company has contributed to the
employee’s social security benefit and it should therefore be entitled to reduce pension ben-
efits by a portion of the social security benefit. With this type of plan formula, a company can
develop a total retirement income objective (plan benefits plus primary social security) based
on the employee’s length of service. The offset method of integration is considered to have
the following advantages:

• The offset can be designed to adjust automatically to increasing social security bene-
fits; therefore, this type of integration can provide a company with some protection
against spiraling benefits and costs.
• Offset integration provides a more direct approach to achieving benefit objectives
(i.e., more equitable distribution of plan benefits to higher-paid employees).
• The offset approach meshes logically with benefit formulas based on earnings close
to retirement. Social security benefits are wage indexed, and therefore an offset is a
logical approach to ensure a more equitable distribution of plan benefits.

In summary, the main difference between excess and offset is that the excess integrates
on the taxable earnings base, and offset integrates directly with the benefit level. For many,
the offset approach is believed to be the more logical one.
Testing the Plan. Earlier, we looked at the competitive level of the combined payouts from
Brucell’s defined-benefit and defined-contribution plans. Now it is time to examine the com-
petitive position of the defined-benefit plan. As shown in Table 6-31, companies are ranked
by the defined benefit and social security, expressing that total as a percentage of final pay—
in this example, $100,000 and 30 years’ service.
Note that Brucell currently ranks fifth; however, we can determine its new rank by
substituting alternative model-plan formulas. While these calculations can be done by hand,
it is far more efficient to use a computer, given the number of combinations involved. For