Its Time To Improve Nonqualified Executive Bonus Plans
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In todays world of nonqualified executive benefit planning, there is a pre-Enron era and a post-Enron era. The corporate scandals that rocked Wall Street over the past year have had a profound impact on all aspects of working with companies and their executives on pay, incentives and benefits.
Companies want executive benefits to be simple, clean, and clear, particularly from a tax and accounting standpoint. Executives want guarantees, security and portability.
In the financial services world, this has led to a new interest in an old idea: Executive Bonus. However, these post-Enron times demand a new form and new features to this concept. It is time to take a fresh new look at executive bonus.
Why is executive bonus back in vogue? One reason is the core benefit that it addresses. While the headlines are focused on those few who used executive benefits to amass huge fortunes at shareholders expense, key employees in most firms are focused on a far more mundane issue: filling the retirement gap.
The retirement gap is the difference between what the employee has for projected retirement income and what is needed in order to retire comfortably. Traditionally, the retirement income gap for the highly compensated employee occurs when Social Security and pension benefits do not meet the employees retirement income needs.
Recently, however, a new gap has emerged: the investment gap. With the precipitous drop in not only returns, but in principal, the executive is challenged to refill the savings pool for retirement. Stock options and other incentive-based benefits may be far too unpredictable to be counted on, especially since they offer little opportunity for diversification. Likewise, with the very public collapse of brand name companies, some employees may be hesitant to allow their employers to defer current income as a way to boost retirement income.
The tragedy of 9/11 also has taught us all that our plans can be interrupted in unimaginable ways. Retirement income planning must factor in contingency planning for unemployment, health challenges, disability and even premature death.
Enter the executive bonus plan. The security of actually owning the financial contract that drives the benefit is compelling for executives. Employees control the product, they decide how it is invested, and they determine the timing of distributions. The benefit is a real and tangible incentive, not just a promise for the future.
For employers, income tax and accounting issues drive the renewed interest in the nonqualified executive bonus plan. The payments are immediately deductible for the business. It works well with pass through companies (S-Corporations, LLCs, etc.), and is not under review with the IRS. Although executive bonus does not offer the same degree of tax leverage as some of the more aggressive benefits that have been marketed recently, it does offer clear and simple tax consequences.
On the accounting side, it does not require booking an ongoing liability. Payments are treated as compensation to the employee in a clear and transparent transaction.
401(k) plans have changed the retirement paradigm. They have taught employees the value of deferring their pay in order to fund their retirement. In contrast, employers still pay the entire cost of a traditional 162 executive bonus plan. It is time to take this approach with executive bonus and rethink how contributions are structured. The idea here, as with 401(k) plans, is to increase the employees sense of ownership, while granting the employee some degree of flexibility.
A truly modern executive bonus program should give the employee an opportunity to contribute toward the solution. Highly paid employees are accustomed to deferring their money with 401(k) plans and deferred compensation plans. An executive bonus can be structured in a similar manner:
The employees own income can fund the program, and then the employer can mirror a 401(k) plan by offering to match the employees contribution;
