Recent Practices For Funding Executive Retirement Benefits

Upper Saddle River, NJ - August 13, 2008 - The Wall Street Journal ran a story on August 4, 2008 which discussed how some companies are moving their Supplemental Executive Retirement Plans (SERPs) obligations into their qualified retirement programs.  The article illustrates current practices some large publicly-traded companies are employing to create what has been termed "Qualified SERPs" ("QSERPs") to fund otherwise non-qualified executive retirement benefits.  These companies are moving tremendous amounts of money from these supplemental non-qualified plans into their qualified pension plans, in order to realize immediate tax benefits and to fund and shelter future payouts to their top ranked individuals.

What does this mean?  In essence, companies have found a way to game the nondiscrimination testing requirement established by the IRS for qualified retirement plans, in order to provide these SERP benefits to their executives and to gain immediate tax deductibility and protection from creditors.  SERPs, as non-qualified plans, are intended to provide executives with increased benefits above those allowed under qualified plan limits.  These plans must be constructed under IRC §409A rules, which includes a requirement that the SERP funds remain an asset of the company, subject to substantial risk of forfeiture.

Under these QSERPs, the payments are made from the pension plan, not out of the general assets of the company.  In this type of arrangement, a significant portion of the assets in the pension plan could be devoted to paying executive benefits, at the possible expense of the pensions for the remaining rank-and-file employees. 

Moving monies from non-qualified plans into qualified plans provides an immediate tax break for the company, and, in essence, removes the risk and virtually guarantees payment of the benefit to the executives.  As deferred compensation, the executive maintains the tax-deferral advantage associated with the benefit, without the inherent risk of forfeiture.  It will be interesting to see how this practice relates to 409A rules on deferrals.

Most disturbing about this practice is the disclosure issues.  The article states, "Companies don't explicitly tell the IRS that an amendment is intended to shift supplemental executive benefits obligations into the regular pension plan."[1]  In today's environment of increased disclosure requirements and the desire for transparency, to many this may appear as a way to hide increased benefits to executives from stakeholders and the public.  Given the number of ways that the QSERP concept appears to flaunt the spirit of the ERISA pension and deferred compensation regulations, it is highly questionable whether it will pass the “sniff test”. Simply put, if it is so complicated that it defies understanding, and just doesn’t smell right, it is probably not right.   It should be interesting to see how quickly this practice may come to an end, now that the spotlight has been placed on QSERPs.

This is an exceedingly complex subject; therefore, reading the article may assist in better understanding what has taken place; visit the Wall Street Journal's website at www.wsj.com.