The dust is just settling after the first
proxy season following the implementation of the SEC’s disclosure rules around executive compensation. The new
policies demand greater candor and disclosure about executive earnings and compensation plans. If meeting the spirit and
intent behind the SEC requirements wasn’t
enough, now public companies must contend with meeting the final rules of IRS
Section 409(A), and the Pension Protection
Act, both of which take effect Jan. 1, 2008.
With the final regulations in place, companies need to revise their deferred compensation plans, including nonqualified
retirement plans, before the deadline.
“Section 409(A) applies to every non-qualified retirement plan,” says Pete
Neuwirth, senior consultant with the
Retirement Practice at Watson Wyatt
Worldwide. “All aspects of the plans are
coming under review, including plan
design, funding and administration.”
Smart Business spoke with Neuwirth
about how CEOs can prepare for the
upcoming changes in deferred compensation and nonqualified retirement plans
required as a result of all the new rules.
How do the new proxy disclosure rules come
into the picture when discussing the Section
409(A) requirements for nonqualified retirement plans?
The proxy filings represented the first
time that we’ve seen many of these executive compensation numbers laid out in
public. At Watson Wyatt, we conducted a
survey of 690 proxy statements, specifically looking at the compensation that was
associated with nonqualified retirement
plans. In general, the pension portion of the
executive compensation was equal to base
pay and averaged about 10 percent of the
total compensation the executive received,
which also included performance-based
compensation and bonuses. For some
CEOs, however, the nonqualified retirement program represented a much larger
component of compensation. One important component of the proxy statements is
to explain the link between performance
and pay for executives. This is difficult to
do for a nonqualified retirement plan.
Because the proxy statements must
include the present value of any accumulated benefits, including deferred compensation, it brings forward the issue of explaining how performance is tied to
deferred compensation and nonqualified
pension plans. The proxy also requires a
discussion of the rationale for adopting the
retirement plan in the first place, something that most companies are not able to
readily do.
What design changes to nonqualified pensions plans do you recommend to meet the
new requirements?
First of all, one size does not fit all. It’s not
necessarily the answer to eliminate all of
your deferred compensation plans, including your nonqualified pension plans, to
comply with the new rules. For example,
the nonqualified plan may have been put in
place for retention purposes or to augment
succession planning goals by helping your
company attract midcareer employees, so
you still want to derive the benefits while
complying with 409(A). You should think
about the type of nonqualified retirement
plan that will best meet your objectives
and, in particular, review how your non-qualified plan dovetails with your qualified
plan. You may, for example, find opportunities to achieve your goals through the
qualified plan, i.e. QSERP. You may want to
consider lowering your Supplemental
Executive Retirement Plan formula and
using total compensation in your benefit
formulas as opposed to base pay only to
better tie the plan to performance. Rather than throwing your SERP out the window,
carefully consider the reasons for the plan
and, where possible, tie the value of the
plan back to performance. Doing this helps
companies meet both the 409(A) and the
SEC disclosure requirements.
How does 409(A) impact funding requirements?
While, historically, there’s been no formal
way to fund nonqualified plans, executives
want some type of security for their retirement funds. That security has generally
been achieved by funding nonqualified
plans through a ‘rabbi’ trust or allowing
executives early access to their benefits
through in-service distributions with a
small reduction, or ‘haircut,’ applied. (The
name comes from the first IRS private letter ruling approving such a trust, obtained
by a synagogue on behalf of a rabbi.)
Unfortunately, 409(A) sharply curtails
your ability to get at funds even if a haircut
is applied. Rabbi trusts, however, are still
viable. While securing against a ‘change of
heart,’ rabbi trust assets are still accessible
by creditors in the event of bankruptcy.
Also, because earnings on trust assets are
subject to income tax, many companies
place the trust assets backing executive’s
deferred compensation into Corporate
Owned Life Insurance (COLI). This funding strategy provides positive tax consequences and security for the executive, but
results in increased frictional costs and a
lack of liquidity.
How does 409(A) change plan administration?
Certainly 409(A) has complicated plan
administration considerably. In the past,
the administration of nonqualified pension
plans has tracked closely with requirements for 401(k) plans. You may want to
consider outsourcing the plan administration since the complexity of 409(A) will
require someone on the staff to be very
attentive to the requirements and, given the
number of people covered by the plans, it
may not make financial sense to keep
administration in house.
PETE NEUWIRTH is a senior consultant in the Retirement
Practice for Watson Wyatt Worldwide. Reach him at (713) 733-4139 or [email protected].
