YOUR BUSINESS AUTHORITY
Springfield, MO
by John T. Piatchek
for the Business Journal
Is the team of executives and technical experts in a small- to medium-size privately held company more or less important to its success than the management team of a major public company? Is it more difficult and more expensive for mid-sized private companies to attract executive talent compared to the mega-operations of international giants?
Small privately held companies may offer many advantages, but smaller almost never means easier or cheaper or fewer headaches. When it comes to recruiting, retaining and motivating executives, all businesses are at risk.
Missing the problem. Many privately held companies of whatever size ignore one of the most valuable tools for executive commitment, utilized by more than 95 percent of the Fortune 1,000: specialized executive benefit programs that enable executives to build personal net worth and retirement income with pre-tax dollars.
Apparently business owners believe these plans won't work in their companies, since surveys indicate only 25 percent offer programs of this kind. Instead, compensation efforts focus on salaries, bonuses and perks.
What compensation strategies most strain a business' capital resources and competitiveness? Salaries, bonuses and perks.
Missing the solutions. Congress inadvertently came to the aid of businesses by creating an opportunity for the highly compensated outside the qualifications and limitations of broad-based pension plans. Nonqualified benefit programs allow businesses to better manage their most important asset the talent and leadership of their executive teams.
One of the reasons business owners have been cool to these programs is that it has been hard for business owners to find consulting sources at a cost they feel is reasonable. But even when CEOs warm up to the concept, the project is usually moved to the back burner as soon as this month's big order gets shipped incorrectly or a new technology development breaks down on the production line.
Essentially, nonqualified benefit choices boil down to three areas:
?The ability to select particular individuals or classes or individuals for participation within your highly compensated group.
?The ability to allow these participants to defer income and therefore avoid current taxes.
?The ability of the company to contribute an additional amount to increase growth potential, and tie these rewards to vesting schedules or employment agreements in order to retain key talent.
A salary continuation benefit is usually referred to as a supplemental retirement plan or SERP. A SERP represents an unsecured promise to pay additional salary amounts at a future time and can be structured either as a defined benefit or defined contribution plan.
The benefit can be either a fixed amount, a percentage of final salary or can be based on a formula that takes other factors into account. Or, the plan can provide defined contributions with the ultimate benefit determined by the contributions plus earnings. SERPs are financed completely by the company, and the participants make no contribution out of current salary.
The second basic category is usually called a deferred compensation plan, in which the participants defer current contributions until a future time. As an incentive to participants, the company may match a portion of the deferrals.
Either way, no income tax is incurred by the participant until the benefit is received.
Participants defer taxes on both compensation and growth, restoring the advantages of company retirement plans before Congress set its limits on the highly compensated.
From the company's side, the trade-off for the ability to offer nonqualified benefits programs is the loss of the ordinary and necessary business expense deduction for plan contributions until such time as they are included in the taxable income of participants.
Missing the liability. But the question remains, where will the money come from?
Should companies implement nonqualified plans and simply wait a decade or two to find out if their cash flow is adequate to pay the benefits? That might produce a plan that looks good for the company short-term, but what happens when the day to pay comes? Such a lack of corporate commitment is not likely to inspire executives to put their own money into such a plan.
A more secure alternative is to informally fund the plan through either investments or corporate-owned life insurance, or a blend of both.
With an investment strategy, the company can select a group of mutual funds, allowing the participants to hypothetically allocate accounts among the funds. The company can either invest directly or credit the executives the funds' performance and manage the investment by another strategy.
Using corporate-owned life insurance, the corporation pays the benefits, then seeks to recover its costs by withdrawing money from the policies until the company has recovered its basis in each policy. Tax-free loans from the cash values can then be utilized.
At the ultimate death of the participant, the death benefit goes back to the company, balancing its outlay. The availability of policy death benefits also allows the benefit plan to be enhanced with pre-retirement survivor benefits that other funding alternatives cannot efficiently provide.
Both strategies need to be carefully analyzed from the perspective of tax consequences.
Whatever the informal funding strategy, probably the most important planning decision for business owners is plan administration.
The flexibility inherent in these plans makes reporting too complicated for the internal resources of most companies. Therefore, the objective analysis of an outside expert resource is imperative, and an investment in administrative services will be vital to the success of the program.
(John Piatchek, CLU, ChFC, CFBS, is a principal with John T. Piatchek and Associates in Springfield.)
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