Participation in qualified retirement plans, such as 401(k)s or some other form of a defined-contribution plan, has always been a mixed bag. Often, despite considerable efforts from companies, participation rates among rank-and-file workers fall well below expectations. When this happens, it obviously jeopardizes future retirement-living standards for those workers. A less obvious consequence is the constraints this situation puts on future retirement incomes for senior executives.
How can low retirement-plan participation among rank-and-file workers impact future retirement for senior managers? Qualified retirement plans, which are tax-deferred, operate under federally mandated nondiscrimination rules, which govern the amount highly compensated employees can contribute to their qualified plan based on overall participation levels. An additional restriction is the annual compensation limit imposed on these plans. For 2008, the compensation limit is $230,000. For an employee under 50, this means the maximum total contribution—regardless of participation levels or actual income level—is 20 percent of $230,000, or $46,000. Of that, the employee’s maximum portion of the contribution is $15,500. For those over age 50, the maximum is increased by $5,000.
Advance planning provides remedies

Given these restrictions, particularly for companies where retirement-plan participation is low, finding additional ways to provide higher retirement income for senior executives can be important for recruiting and retention purposes. It takes good planning, but there are several options available. Generally, they include:

• boosting overall retirement plan enrollment
• creating specific types of qualified retirement plans
• offering exclusive supplemental retirement and compensation plans (SERPS)

Boosting overall retirement plan enrollment helps increase the amounts senior executives are allowed to contribute, but it can be difficult to convince rank-and-file employees to begin contributing to these plans. Some workers do not believe they can afford to defer a percentage of their current income to contribute to their future retirement. Others procrastinate or simply do not understand enough about the program, so they resist enrolling.

To build participation, some companies have increased communication, created promotions and even made significant changes to their plans, such as faster, simpler applications and automatic enrollment. For plans with automatic enrollment, employees must opt out, which means natural procrastination tendencies work in favor of increased plan participation. Increasing enrollment, however, is often not enough to fully compensate senior managers.

Creating specific types of qualified retirement plans is another option. Some companies create safe-harbor 401(k) plans, which offer automatic contributions in accordance with specific federal guidelines. Plans meeting these guidelines are able to sidestep nondiscrimination tests, which allow all eligible employees, including senior management, to maximize their contributions.
Employee eligibility and contribution requirements for safe harbor 401(k) plans are the same as for other 401(k) plans, with one exception. In these plans an employer is required to make a 100 percent vested contribution for each employee or a matching contribution that adheres to federal requirements. There are several ways to structure these plans but they must provide all employees with an equal employer contribution.
For some companies with collectively and non-collectively bargained employees, separate qualified retirement plans are an option. Creating two plans tends to group highly compensated employees together, which decreases the likelihood that senior executives would face restriction on their contributions.
While these plan options may help, the annual limits on contributions to tax-deferred plans may still be inadequate for some highly compensated employees.
The final option, exclusive supplemental retirement and compensation plans, or SERPS, provides the most flexibility. Companies are not required to provide these benefits to all employees, so they can offer senior managers additional retirement compensation though this approach. SERPS are variously designed, but many offer some combination of elective compensation deferrals, various stock options, stock bonus plans or stock appreciation rights (SARS). SARS are an obligation to provide compensation, generally based on the value of a company’s stock, at a particular point in time, such as retirement. Non-qualified benefits are not protected from creditors, however, which mean senior managers could become creditors in a bankruptcy proceeding, for example, and potentially lose these benefits.
Often non-qualified compensation plans are associated with “rabbi trusts,” which are agreements between an employee and employer for payment at a specified future time. Nondiscrimination rules to not apply to rabbi trusts, so they can be provided exclusively to certain employees and, properly structured, they allow income tax deferrals for the employee.
Other compensation typically offered to highly compensated employees include various “perks,” such as tax preparation services, paid legal work or financial planning or any number of other benefits. However, these perks generally do not directly contribute to retirement.

Providing appropriate retirement compensation for highly paid senior managers does take planning, but it is often necessary to retain top talent.

Alan Goldfarb is director of Financial Strategies for Weaver and Tidwell Financial Advisors Ltd. (www.wtadvisors.com) in Dallas, Texas. A Certified Financial Planning practitioner, Goldfarb has been named Top Financial Advisor by Worth magazine six times. He holds an MBA in economics and management from the University of North Texas and a bachelor’s degree in engineering and management from Fairleigh Dickinson University. He can be reached 972-960-1100.

Lost amid the political rhetoric swirling around Social Security are many of the other benefits the system provides. For example, the right to choose when to start drawing benefits can be as important as the benefits themselves. Often overlooked are the benefits Social Security provides the families of retired workers, or the benefits that are available to families of deceased workers.
The right to choose a retirement date impacts the payments a worker receives. To test the value of this right, use the projected benefits for a worker age 62, who has earned the maximum amounts during his lifetime. To calculate this, use the Social Security Cost of Living Allowance (COLA) from the Social Security web site, www.ssa.gov, and a 3% discount factor.

Using the Social Security Quick Benefits Calculator for inflated dollars, our worker would receive $1,434 per month if retiring today, $2,163 a month if retiring at the normal retirement age of 66, and $3,314 a month if retiring at age 70.

To determine which is better financially, using the above assumptions, our worker is ahead using a Net Present Value calculation if he waits to draw benefits at full retirement age and lives to age 83. Benefits at age 66 are slightly better than waiting to age 70.

The longer the life expectancy of the worker, the more advantageous it is to wait to age 70. This advantage is even more pronounced if the worker’s spouse is considerably younger and expected to outlive the worker. In the latter case the surviving spouse’s lifetime income would be based on the worker’s higher payout.

Drawing benefits at age 62 are more advantageous if the worker’s life expectancy is shorter. Using my model, our worker is better off to draw at 62 if he/she dies by 69. For anything beyond that point, waiting to draw at full retirement or even delaying to age 70 is financially a better choice.

A worker would not opt for the early retirement if still working. Earnings above $12,000 in 2005 will reduce his benefit by $1 for every $2 he earns until normal retirement age. For the year of full retirement age, our worker would have $1 deducted for every $3 earned above $31,800 before the month he reaches full retirement age. The government does not count pensions, annuities, investment income and interest, veterans or other government or military retirement benefits as earnings.

If our worker became disabled today, he/she would draw $1,912 a month while his children would be entitled to $1,434 per month and his spouse caring for children under 16 would draw $1,434. The maximum spouse plus children could draw would be $3,347 a month.

If our worker married late in life and retires with minor children the system pays each of those children one half of his retirement benefit until they are 18, or 19 if still in a secondary school. His spouse will also receive a comparable benefit if at least one child is under 16. Again this family benefit is subject to a maximum of 1.5 times the worker’s retirement benefit.

Finally, Social Security provides a healthy life insurance benefit for families. The surviving spouse of a worker may begin drawing benefits based upon the worker’s earnings at age 60, albeit reduced. This same benefit is available to the divorced surviving spouse who was married ten years or more to the worker and who has not remarried.

Finally, for a family of a worker age 35 who dies today, and has earned the maximum Social Security wage ($90,000 in 2005) would receive a life insurance benefit of $1,470 per month per child under 18, and $1,470 a month for a spouse caring for a child under 16.

Bruce Fenton is a financial consultant, a writer, and the Managing Director of Atlantic Financial Inc. Bruce welcomes inquiries, comments, and questions. He can be reached by contacting The Fenton Report.

Our Social Security System has roots back in the 1870s when public policy began to accept the fact that Americans were moving from the farm to the industrialized city. With this change came the realization that workers’ welfare should be protected. Both states and federal governments began to adopt laws such as a workers’ compensation to protect workers injured on the job.

Early in the 1900s retirement plans were beginning to sprout up for city and state employees. The Great Depression brought shrinking personal savings and lack of employment to the nation. Concerned that workers would be without resources at retirement, the Roosevelt Administration acted to put in place a retirement income supplement plan, followed in 1940 with a survivor assistance plan.

The result is now the largest public assistance program in the world, funded by a combination of worker and employer contributions. While we would like to believe that the money we contribute is set aside in individual accounts, nothing could be further from the truth, as the program has become a “pay as you go” plan.

Policy makers are struggling with the thought that as the work force declines…as it will because of the age wave of baby boomers retiring… there will be fewer workers working and contributing to the system.

Advocates for a form of privatization point to the fact that the current Social Security System does not provide enough incentive for people to save. Steven Landsbury in his book, The Armchair Economist, stated “most of economics can be summarized in four words: People respond to incentives.”

There is a fascinating article from the Cato Journal entitled “Empowering Workers: The Privatization of Social Security in Chile”. Author Jose Pinera describes the successes Chile has had with privatization of their national retirement system.

In its first 15-years of operation, pensions in the new private system already are 50 to 100 percent higher than in the old “pay as you go” system. The resources of the private fund accounts are equivalent to almost 40% of GNP as of 1995. Because of the stimulus from additional savings and investment, the Chilean economy has grown at a rate of 6.5% annually as compared to 3%.

Under Chile’s Pension Savings Account (PSA) a worker’s pension level is determined by the amount of money he accumulates during his working years. Neither the worker nor his employer pays a tax into the system. Instead, the worker has a mandatory 10% withheld from his paycheck up to a pay base of $22,000. He may also save an addition tax-deductible amount of 10%.

The worker chooses a Pension Fund Administration company, similar to a mutual fund. Workers may change companies, which provide incentives for the private companies to achieve higher returns. The return within the account is tax-free, but when withdrawn the worker pays income tax on the amount.

For workers who have not contributed enough by retirement, the government has a standard for a minimal subsidy. At retirement the worker may chose to purchase an annuity from a private insurance company or take his money out over time with a series of withdrawals. Should he die before his funds are exhausted, the balance becomes part of his estate…a quite different plan from our Social Security System. A system like this one has clear benefits as well as disadvantages.

Personally I believe that some changes are needed with the current plan. The solution may not be as easy as privatization since this carries drawbacks with it as well. It will be interesting to observe how this unfolds. In any event, investors who keep abreast of this important issue and plan for any eventuality will be better off than those who do not.

The original intent of Social Security was to provide government sponsored security for widows and orphans. Its secondary purpose was to provide a retirement supplement. Over the years, liberal politicians and economists have pushed Social Security as a national “savings” plan for retirement.

Nothing could be further from the truth. The Social Security system has become a pay-as-you-go entitlement program made possible by creative Washington bookkeeping. Theoretically, Social Security tax revenues go into a Trust Fund that is invested in U.S. Treasury securities.
The reality is that the tax revenue generated by Social Security goes into the Federal revenue stream where it is accounted for as income that is used to pay government operating expenses. Deposits to the Trust are paper entries.

The idea that the Trust will run out of money for retirement benefits has nothing to do with running out of money. It has everything to do with the fact that the work force will be shrinking, which will result in lower payroll tax revenues that pay current benefits, at a time when more people will be looking for their benefits.

Here is a radical idea for you to consider. Perhaps this dysfunctional, convoluted, last gasp of Socialized Government, is actually doing some good in its present form.

The operative word to describe this paradox might be “Incentive.” Steven Landsburg in his book, The Armchair Economist, stated “most of economics can be summarized in four words: ‘People respond to incentives.’”

Social Security has become nothing more than a big disincentive to save. Those depending entirely upon Social Security for their retirement will tell you that their incentive to save for retirement was diminished by their belief that they would be taken care of by Uncle Sam.
In 1986 and 1987, radical changes to the Federal tax code did away with a number of incentives for business-sponsored defined-benefit pension plans. These plans provided for a guaranteed retirement benefit for retired workers.

In place of those plans has come company sponsored retirement savings plans. These plans shift the responsibility for retirement savings from the government and company to the employee.

There is clear evidence that these changes have had a positive impact on both the economy and personal wealth. Edward Yardeni, chief economist for the Deutsche Morgan Grenfell bank cites statistics showing that from 1989 to 1995, the percentage of families holding retirement assets rose from 35.4% to 43.0%. The percentage of families with 401k plans increased from 19% to 27% during the same time period. Defined benefit plans, on the other hand, fell from 28% in 1989 to 19% in 1995.

The effect of this increased cash flow into self-directed retirement accounts has been nothing but positive. Since Americans now have more say in how their money is invested, they have opted for investments that offer higher returns—equities.

Yardeni points to the positive correlation of stock market returns with this increased savings activity. Since 1989 household investments in stocks and mutual funds have risen from 31.7% in 1989 to 41.4% in 1995. And, the stock market during this period has continued to show a strong, secular trend…upward and to the right!

Maybe, just maybe, our Federal lawmakers will take heed, and look to some form of privatization as the “fix.” The American worker has proven quite adept at responding to incentives to save and to self-direct their retirement accounts.

Today, about 98% of all workers are in jobs covered by Social Security. One in six Americans receives a Social Security benefit, and nearly one in three beneficiaries is not a retiree. According to the Social Security website, http://www.ssa.gov/ , Social Security benefits comprise about 5% of the nation’s total economic output.

To be eligible for benefits, a worker needs to be employed and subject to Social Security taxes for 40 quarters. A fully insured status enables the worker to receive unrestricted retirement, disability and survivor payments. To be eligible in any quarter, a worker must earn at least $870.

Benefits payable are determined using a formula for the average indexed monthly earnings (AIME) that takes into account the worker’s top 35 earning years since 1950.
The retirement benefit amount may be equal to, less than, or greater than the AIME. If the worker chooses to retire early, say at 62, the earliest age for retirement, the amount is reduced by approximately .56% for each month before normal retirement age (generally 65). If the worker elects to delay receiving benefits beyond the normal retirement age, but prior to age 70, the benefits are increased by 8% a year up to 140% of the normal benefit.

A retired worker’s spouse may elect to receive the greater of one-half of the worker’s benefit or his or her own benefit. It does not matter if the primary worker is still working and has not begun to draw benefits—the spouse may draw at his or her eligible age.

A divorced spouse who has been married for ten years or more to an insured worker and who has not remarried may draw under the same rules as a married spouse. This does not impact the benefits available to the insured worker. As a matter of fact, the insured worker could have several divorced spouses drawing upon his or her benefit, and could also be currently married to a spouse drawing benefits.

The minor children and spouse caring for minor children of a retired worker may be eligible for benefits. For those of you who became parents when you were older, your children under the age of 18 (or 19 if not graduated from high school) will receive a check equal to one-half of your benefit. The same goes for your spouse if he or she is caring for a minor under age 16. The total payable to a family is limited by a family maximum benefit calculation.

Finally, if an insured worker passes on, his family is entitled to certain benefits. Children under age 18 (or 19 if not out of school) receive a benefit, as does a spouse caring for a minor child under age 16. The amount is subject to family maximums and is dependent upon the worker’s AIME. A surviving spouse may elect to draw a widow’s benefit at age sixty, whether or not he or she was married to the worker at his/her time of death.

The Social Security website contains a wealth of information on benefits and rules as well as a useful retirement planning calculator. The latter will help you estimate your benefit based upon different scenarios for retirement, earnings and family situation.

Bruce Fenton is a financial consultant, a writer, and the Managing Director of Atlantic Financial Inc. Bruce welcomes inquiries, comments, and questions. He can be reached by contacting The Fenton Report.