Howard Edelstein has a warning for financial services executives: your normal retirement benefits won't give you enough to live out your sunset years.
In the following article, Mr. Edelstein, a principal with the Cleveland office of the Todd Organization, a national benefits consultancy, argues that executives should negotiate for nonqualified benefits to help make up for the shortfall in qualified benefits such as 401(k) plans.
A career in banking once meant a job for life. But let's face it, those guaranteed positions are long gone. For every headline clamoring about the latest industry merger, product innovation, and new banking technology, there is another that announces layoffs.
In all this uncertainty, the need for maintaining steady income now often tramples concerns over seemingly distant financial needs, such as setting aside money for retirement.
But that can be a costly, shortsighted mistake; the need for taking steps to secure a strong financial future is more important now than ever.
Here's why: The growing legislative restrictions on traditional pension plan contributions have left a large number of U.S. workers at risk of retiring with far less annual income for their golden years than they need- and far less than they were accustomed to earning during their final years on the job. Since it has not been well-publicized, many bankers may not even know they are heading for trouble.
The 1993 federal tax package dealt a severe blow to the upper limit that employees can contribute to qualified benefit plans. Qualified plans, such as 401(k)s, are those that "qualify" for tax-deductible funding and tax- deferred earnings on plan assets, and protect employees under the Employee Retirement Income Security Act of 1974 (Erisa).
Under the 1993 tax law, the "considered compensation" limit-the maximum eligible compensation on which benefits from a qualified plan can be computed-was reduced to $150,000 from $235,840, a 36% drop. Although the limit has since been increased to $160,000, this considerable plunge in potential retirement savings means that the employee's annual retirement income from qualified plans will become a smaller percentage of final salary the more it exceeds the $160,000 ceiling.
But how much money is enough? Retirement planners say that 65% to 70% of final-year compensation is the minimum needed to maintain the economic standards a retiree enjoyed in his or her working life. This suggests that a financial services manager expecting to earn $100,000 during his or her final working year will need $65,000 to live on for each year they will be retired. Multiply that by even 10 years and the number is staggering.
Yet a recent study conducted by the Todd Organization and Case Western Reserve University's Weatherhead School of Management indicates that 80% of top executives will not even receive 35% of final pay through traditional corporate-offered benefits like pension plans and 401(k)s. Without additional sources of retirement income, these retirees will undoubtedly find it very difficult to maintain their lifestyles.
To help employees bridge this retirement income gap, more and more financial institutions are establishing special benefits known as "nonqualified plans." They are designed to generate income to help replace the retirement shortfall brought on by qualified benefit plan contribution limits (currently $10,000 annually at most).
Like other types of benefits, several types of nonqualified retirement plans are available. Deferred compensation plans are the most common and are often structured to mirror the performance of a 401(k) plan. Under this plan, the banker defers pretax income in exchange for the employer's agreement to pay specific retirement benefits. Other common ones are:
Capital accumulation plans, which are common among companies with significant bonus programs. These plans allow employees to set aside large portions of earned income on a pretax basis at either a fixed rate or one tied to the performance of a separate investment vehicle.
Restoration SERPs (supplemental executive retirement plans), which provide a benefit equal to the full amount that the executive could have received under the company's pension formula if you take away regulatory and legislative limits.
Target SERPs, which promise a specified percentage of final pay (usually around 75%) at retirement.
There are compelling reasons why senior and mid-level bankers should negotiate for nonqualified benefits, and equally strong reasons why their employers will seriously consider providing them. Unlike qualified retirement plans, nonqualified benefit plans are extremely flexible; they can be custom-tailored to meet the compensation objectives of an individual or a select group of employees.
Although this exclusivity leaves them outside the boundaries of ERISA, there are ways that companies can setup the plans so that they mirror the design, tax consequence and security of qualified plans.
For the employee, the most powerful reason to have a nonqualified plan in place is that it will enable him or her to achieve the recommended minimum retirement income level of 65% to 70% of final pay. Equally important is the fact that they offset reliance on Social Security as the primary tool for supplementing personal savings, IRAs, and 401(k)s.
But one reason that may be of particular importance to bankers is their ability to protect the employee's interest in the time of a change in corporate control. A sizable number of corporate retirement programs are unfunded, making them little more than unsecured promises that can be easily affected by corporate financial insolvency or changes in management structure and company ownership.
Nonqualified plans, however, can be structured to protect against these outcomes. This advantage alone makes these plans well worth considering given the frenetic pace of industry consolidation.
Nonqualified plans have attractive tax implications as well. As with qualified benefits, there are no tax consequences until the money is actually paid to the employee by the bank. Since these plans are designed to defer compensation earned in one period until a future date, bankers can postpone receipt of the funds until a time when tax penalties may be less.
Nonqualified benefits may sound like a perk reserved only for the upper echelons, but they are becoming increasingly pervasive among the ranks of mid-level management-and not just in large banks. Innovative financial services companies of all sizes recognize that nonqualified plans are a valuable management tool for attracting, retaining, and rewarding key managers.
Since the rewards generated by these plans can be tied to the company's financial performance or achievement of company goals, these plans are particularly useful motivators as well. Beyond this, there are considerable tax and accounting benefits and cost reductions for the banks that provide them.
Nonqualified plans can be a powerful tool for both employer and employee, and are worth looking into.
