By Alan Goldfarb

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.