Employee Benefits

by William F. Fishbach

Adequate retirement planning is one of the more critical issues for today's executives. The qualified 401(k), one of the most popular retirement programs, has become a standard in many companies.

Under a 401(k) deferral plan, employees are permitted to contribute to a retirement savings plan and reduce their salaries on a pre-tax basis. The deferred amounts are not taxable to the employees until received in the form of a benefit payment.

While these plans have grown in popularity in recent years, there are limitations which can greatly impact the highly compensated employee:

?First, there is a limitation on the amount that can be deferred on a pre-tax basis. The limitation for 1998 is $10,000. This amount is often insufficient to fund the desired standard of living for the highly compensated executive.

?Another limitation is the amount of compensation that may be considered for benefit and contribution purposes. The amount for 1998 is $160,000.

?Contributions are also limited by Code 415 to the lesser of 25 percent of compensation or $30,000.

?Perhaps the most significant limitation has to do with the effects of non-discrimination tests on the contributions of the highly compensated employee. These tests are the actual deferral percentage (ADP) and actual contribution percentage (ACP).

This means that the highly compensated employee will probably not be able to reach the $10,000 annual deferral.

The ADP establishes a contribution maximum for the highly compensated based on the levels of participation of the rank-and-file employees. If the rank-and-file choose not to participate at a high percentage level of earnings, or waive out of the program entirely, this can drastically effect the highly compensated.

For example, let's assume your group's 401(k) has an ADP of 2 percent. The highly compensated employee, defined this year as making over $80,000 a year, can only contribute an additional 2 percent above the ADP.

In this example, the employee can contribute a total of 4 percent. Assuming this employee is earning $100,000 a year, the maximum contribution is $4,000. This is a far cry from the maximum limitation amount of $10,000.

The 401(k) wraparound plan avoids all of these limitations.

The 401(k) wraparound plan is a non-qualified, deferred compensation plan that can supplement or in some cases even replace the qualified 401(k) plan for the highly compensated.

In 1995, the IRS issued a favorable ruling on the non-qualified 401(k) wraparound arrangement. In addition, the 401(k) wraparound also avoids many of the burdensome requirements of the Employee Retirement and Income Security Act of 1974 (ERISA).

Similar to other non-qualified arrangements, the 401(k) wrap-around can be designed to meet the needs of each individual employer and executive.

This can be an invaluable tool for recruiting, rewarding and retaining key employees. The opportunity for more personally tailored programs allows the employer and executive to utilize additional compensation and benefits which otherwise would not be permitted under a qualified plan.

?The non-qualified 401(k) wraparound plan can be structured to allow the executive to defer unlimited amounts of current compensation. This means that, at the very least, the program can be structured to bring the participant up to the $10,000 qualified limit when the ADP has restricted the amount as in the example above of a $4,000 contribution. However, the program can even be tailored to exceed the $10,000 cap.

?The employer also has an opportunity to match the executive's deferral without limit. This means the executive can build a much greater retirement account than would otherwise be possible under the qualified 401(k).

?The plan can discriminate as to who participates, and the benefits can vary. This program is intended to serve and secure the handful of employees who are essential to the building or maintaining of a successful organization.

?The plan can be terminated or suspended without adverse tax results and requires only limited ERISA compliance. This translates into savings on administration expenses.

?The program can be structured so as to provide cost recovery to the employer.

None of these features is possible with the qualified 401(k).

The non-qualified 401(k) wrap-around plan is a written agreement between the company and the executive. Similar to other non-qualified deferred-compensation plans, some of the 401(k) wraparound plans are unfunded.

However, with much greater mobility in the work force these days, baby boomers don't assume they will stay with the same company for their entire careers, and they aren't comfortable without seeing some cash being paid out by the employer.

There are a variety of funding options available for the 401(k) wrap-around including treasuries, tax-exempt securities, common stock, corporate annuities and managed portfolios. However, the trend is toward informal funding with the use of corporate-owned life insurance, which has several advantages over the other funding vehicles:

?Cash values generally accumulate income-tax-free to the company.

?Benefits can be paid from policy withdrawals, surrenders or loans.

?Death benefits provide a cost recovery to the employer. This includes the present value of future payments, premiums paid to date and the opportunity costs of all outlays.

Clearly, employers are attracted to the 401(k) wraparound plan as a tool for meeting the challenging task of attracting, rewarding and retaining key executives. And, with the changing and uncertain role the U.S. government will play in retirement security, key executives view these plans as essential.

(William F. Fishbach is an account executive with BPJ Insurance, specializing in designing corporate executive benefits.)

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