Page 345 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

Chapter 6. Employee Benefits and Perquisites 331

• Stock option plans provide the opportunity to purchase at any point along a pre-
scribed time period, whereas stock purchase plans stipulate the intervals at which the
stock is to be purchased.
• Stock option plans allow the company to determine the number of shares to be optioned
by individual, but stock purchase plans require that all participants be eligible for a
number determined by a common formula.
Companies that use both stock option (perhaps for executives) and stock purchase plans
(perhaps for all other employees) find that depending on stock price movement, one is
better than the other at any point in time.
Individual Retirement Account. The individual retirement account (IRA) was introduced
in 1974 with the adoption of ERISA and has been modified a number of times since by tax
legislation. As described in section 408 of the IRC, the IRA permits an individual to make an
annual tax-deductible contribution of 15 percent of earned income up to a $4,000 annual
maximum (scheduled to rise to $5,000 in 2008) to an IRA account established with a finan-
cial institution (e.g., bank, broker, insurance company, or other investment house). The law
prohibits including collectibles, life insurance, and personal property. It also prohibits trans-
actions with the IRA’s owner and spouse, parent, or children. Distributions from the IRA can-
not be sooner than age 59 1/2 without a 10 percent tax penalty or begin later than age 70 1/2
by either lump sum or life annuity equivalent. However, the IRS may permit a lowering of
the minimum withdrawal based on the combined life expectancy of self and a named benefi-
ciary. A spouse 10 or more years younger could be a big help. The amount that is tax
deductible is dependent on the person’s income level, and above a level well below an execu-
tive’s salary, no deduction is permissible. Therefore, the traditional IRA is of no value to the
executive, except to ensure that children who qualify do set up IRAs, permitting the power
of compounding to take effect. Babysitting and newspaper route jobs can qualify preteens
to set up and contribute to their own IRA. The sooner they start, the more that will be
available when they retire.
The greatest appeal of IRAs to executives is when they are set up to receive a lump-sum
distribution from a qualified pension plan after the executive leaves the company. Given the
alternative of immediate taxation on the lump sum in addition to a penalty tax for early with-
drawal (namely less than age 59 1/2), a tax-deferred rollover into an IRA makes a lot of sense.
Defined-contribution plans usually pay out in lump sums and, therefore, are simple to roll
over into an IRA. If the amount stays with the employer, the executive may find postretire-
ment investment choices are limited and the withdrawal schedule less than attractive. Many
defined-benefit plans permit the conversion of the annuity into a lump sum that can be rolled
over. However, those under a career-earnings plan with periodic updates may find it to their
advantage to take the annuity and forego the IRA rollover because later updates will apply
only to the annuity but not the lump sum if taken. Should the executive join a company with
a defined-contribution plan accepting rollovers, the executive may choose to do so or keep it
as an IRA, depending on investment alternatives.
A variation on the tax-deductible IRA is the Roth IRA (so named for the senator who spon-
sored the legislation). It is not tax deductible, but individuals are able to set aside a maximum
of $4,000 a year. Investments accumulate tax free and may be withdrawn at time of retirement
(but not before age 59 1/2) without being taxable. However, it too is of little interest to execu-
tives because of the low contribution limit, although it may be attractive in estate planning if,
after death, the accumulated assets can be passed to heirs without incurring income taxes.