Page 336 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

322 The Complete Guide to Executive Compensation

While profit-sharing plans typically include all employees, there are alternatives. Highly
paid employees could be excluded by title or level of pay. Alternatively, they could be included
but only up to a specified earnings level.
Profit-sharing plans may pay out in stock, cash, or a combination. Those paying out solely
in company stock are frequently identified as stock plans, but they are still profit-sharing plans.
Plan provisions may permit loans and/or withdrawals prior to leaving the company subject to
IRS regulations. However, premature distributions may be subject to a penalty tax.
Profit-sharing plans fit better in egalitarian, team-focused companies than in companies
that focus on individual performance. Nonetheless, they help employees focus on improving
productivity and, thereby, profits. However, company size is a factor. The ability to identify
personal impact for a person in a company of 10,000 is far less than one with 100. However,
even with the smaller organization, the “line of sight” between individual performance and
company results is neither as straight as a laser nor crystal clear.
Stock Bonus Plans. These plans are similar to profit-sharing plans: neither requires a con-
tribution formula, each must have ongoing substantial contributions, and each has a formula
for distributing employer contributions. But there are several significant differences: stock
bonus plans consist of employer stock (profit-sharing plans typically include other assets), and
stock bonus plans make distribution in shares of company stock (profit-sharing plans
typically pay out in cash).

Savings/Thrift Plans. Section 401 of the IRC considers a tax-qualified savings or thrift
plan (the two are synonymous) as a type of profit-sharing plan. However, unlike the typical
profit-sharing plan, savings plans normally require an employee contribution in order to
receive an employer contribution. That contribution is a percentage of the employee’s
contribution. The employee’s contribution in the form of a payroll deduction is typically a
percentage of pretax income but is made from after-tax pay.
The plan specifies the percentages of pay the employee may contribute to the plan and
what portion of these contributions will be matched by the company and at what rate. A rep-
resentative formula would be permitting the employee to contribute in 1 percent multiples
from 1 to 15, with the company matching an equal amount for the first 5 percent. This would
result in a maximum contribution of 20 percent of employee pay. A profit-sharing type
feature could be added on where, depending on company profitability, an additional amount
would be contributed by the company, subject to the previously described allowable
tax-qualified maximum. If possible, the individual should set aside the maximum allowable
(15 percent in the above example) to capitalize on the power of tax-deferred compound
growth, which will be illustrated later. At the minimum, the individual should set aside the
maximum amount on which the company matches the contribution. In the above example,
that would be 5 percent.
Normally, the company contribution is in the form of company stock or dollars to
purchase company stock, whereas employees normally have several choices about how their
dollars will be invested (e.g., fixed-income fund, common stocks excluding own company, and
company stock). Persons aged 55 or older with 10 or more years of service are able to diver-
sify a portion of the company matching contribution each year. For years one to five, this is
25 percent of the account balance, and for years six and beyond it is 50 percent.
Given allowable payroll deductions, company contributions, and investment alterna-
tives, one needs to decide how much to set aside and in what funds. This will result