Page 346 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

332 The Complete Guide to Executive Compensation

Keogh Plans. A Keogh plan (named after the congressman who introduced the legislation in
1962) is also called an H.R. 10 Plan (the U.S. House of Representatives number assigned to the
bill). The plan permits the self-employed to participate in tax-qualified plans. In 1974, ERISA
raised the yearly limits to the lesser of 20 percent of earned income or $7,500. In 1981, legisla-
tion increased the dollar maximum to $15,000. With the Tax Equity and Fiscal Responsibility
Act of 1982, the maximum limits for defined-benefit and defined-contribution Keogh plans were
changed to conform to those of corporate plans. Early withdrawal features are similar to IRAs.
While employed by the company, executives cannot use Keogh plans against their com-
pany earnings, but they can use them for noncompany income (e.g., director compensation
if they are on other company boards). However, since many companies allow directors to
defer all of their compensation, the Keogh plan is not often used.

Simplified Employee Pensions. The Simplified Employee Pension (SEP) was introduced
with the 1978 Revenue Act and looked like a Keogh regarding annual limits but was targeted
for small employers who wanted no part of complicated federal pension rules and regulations.
It is described in Section 404(h) of the IRC. SEPs therefore have an IRA appearance. In addi-
tion to small businesses, the self-employed could set up SEPs, thereby crossing over into
Keogh land officially. The rules are similar to qualified retirement plans for eligibility, contri-
butions, and vesting, but less complex if it is a hybrid combination of defined-contribution
plans. However, there are hybrid defined-benefit/defined-contribution plans as well.

Savings Incentive Match Plan for Employees (SIMPLE) Pensions. It is not surprising
that SIMPLE pensions are often confused with Simplified Employee Pensions. SIMPLE
plans are described in Section 404(m) of the Internal Revenue Code; Simplified Employee
Pensions are described in Section 404(h) of the IRC. A SIMPLE plan may be either IRA
or 401(k) in nature but cannot be used if the company has another type of retirement plan.
Although reporting requirements are more modest than other pension plans, the limits
on contributions make SIMPLE pensions more popular with smaller companies and
self-employed individuals.

Hybrid Plans
As the name suggests, hybrid plans have both defined-benefit and defined-contribution
features. Their emergence is in response to the need for more customized pension plan
designs, addressing both employer and employee objectives. The employer seeks predictable
cost, whereas the employee looks for investment opportunity and portability of benefits.
While many profit-sharing plans are self-standing, some are combined with pension
plans in an either-or situation. Typically, the pension plan (defined benefit) prescribes the
minimum benefit using one of the formula approaches described earlier. The profit-sharing
plan stands alongside the pension plan, and the employee will receive whichever produces the
greater benefit. Pension-plan liabilities are thus reduced by sustained periods of high com-
pany contributions to the profit-sharing plan. The employee still sees a very visible accumu-
lation of assets, which form the minimum payout at time of separation from service.
Furthermore, this approach combines the advantages of both while canceling several basic
disadvantages. More specifically, defined-benefit plans favor older employees as plan
improvements extend not only to future but also past service. Defined-contribution plans are
by definition always fully funded programs that provide younger employees many years in
which to build up plan values. However, withdrawal requirements exist to avoid a penalty tax.