Page 91 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

Chapter 3. Current versus Deferred Compensation 77

defer are assumptions about current and future events (e.g., taxes, inflation, risk of forfeiture,
investment opportunities, and need for liquidity). Some take the simplistic view that it will
always be beneficial to defer dollars (which will be highly taxed now) to a point in the future
when income (and tax rates) will be lower. While this may have been true when marginal
taxes were as high as 94 percent, it is not true when marginal maximums are 40 percent or
less, since the opportunity for a significant reduction is lessened. Furthermore, there is less
of an executive need to defer due to improved pension plans and capital accumulation pro-
grams, although, as will be shown in the chapter on employee benefits and perquisites, the
company typically supplements qualified pension benefits with nonqualified amounts.

VOLUNTARY AND INVOLUNTARY DEFERRALS

Deferred compensation is either voluntary or mandatory in nature, and can be applicable
to each of the five compensation elements (i.e., salary, short-term incentives, long-term
incentives, employee benefits, and perquisites).
The most common types of involuntary deferral are pension plans, stock awards, and
severance payments, although mandatory deferral of a portion of pay is also possible. Under
a mandatory plan, the company unilaterally defers a portion of compensation in accord with
a schedule (e.g., equal installments from the short-term incentive award over three years
beginning now, or equal installments from a long-term incentive plan over 10 years begin-
ning at retirement). The most common forms of voluntary deferral are receipt of a portion
of salary or incentive payment. Under voluntary plans, the individual enters into an agree-
ment with the employer to defer a portion of compensation (e.g., salary, short- or long-term
incentive payment) for a stated number of years. Such plans range from qualified retirement
plans (where deferral is an inherent characteristic of the defined benefit or defined contribu-
tion plan) to personalized employment contracts. Thus, the spectrum runs from arrange-
ments open to all to individually negotiated agreements, the latter often in conjunction with
employment negotiations.

TYPES OF DEFERRED COMPENSATION

Plans are either funded or nonfunded, qualified or nonqualified, and forfeitable or nonfor-
feitable. As shown in the matrix (Table 3-1), this results in eight possible combinations. We
could add voluntary or involuntary, however, that would make it unnecessarily complicated—
viewing 16 combinations, many of which are impossible to do.

Type of Plans Forfeitable Nonforfeitable
Funded
• Qualified 1 3
• Nonqualified 2 4

Nonfunded
• Qualified 5 7
• Nonqualified 6 8
Table 3-1. Type of deferred compensation matrix