Though the financial services industry continues to thrive, institutions that want to attract and keep top-notch executives face a key challenge arising from projected shortfalls in these executives' retirement income. Financial institutions that fail to confront this issue risk losing talented executives and even incurring charges against future earnings.

This problem has been building for two decades as the federal government has steadily, though quietly, reduced the amounts that can be contributed to and received from qualified retirement plans - pension, profit sharing, and 401(k) programs. Today many financial services executives who earn more than $85,000 a year need supplemental, or nonqualified, retirement plans if they are to get the same proportion of retirement income as rank-and-file employees.

Just how significant is the impact of retirement plan restrictions? In the case of a 45-year-old bank executive earning $125,000 a year it is dramatic. Here's why:

Retirement consultants generally advise having a retirement income that equals 70% of final salary. But though an employee earning $50,000 a year can typically meet this threshold through a pension plan and Social Security, the $125,000-a-year executive would only get 45% of final pay at retirement due to qualified plan limits.

In addition to top-tier executives those facing potential retirement shortfalls from qualified plans include directors of cash management services, product development and senior operations executives. Each of these groups was found to have an average salary and bonus exceeding $85,000 in a recent compensation survey by the Association for Financial Professionals.

What should financial institutions do? Here are three important steps:


First, evaluate your retirement plans - regularly and frequently - to make sure they help to attract, retain, and motivate key executives. Questions to ask in this regard include the following:

Is there a supplemental plan? Why was it adopted? How many executives does it cover and what amount of support is provided? How does this compare with what our competitors are offering?

If the bank does not have a plan, why has it chosen this course? Often, executives will place greater value on having a supplemental retirement plan than on higher salary.

Rampant merger and acquisition activity has made it imperative for many institutions to reevaluate their plans in order to reconcile differences between the two parties in a consolidation.

Assess the Plan's Financing

The quality of a nonqualified or supplemental retirement plan will usually be determined by how well it is financed and administered. In fact nonqualified plans can be structured to have many of the advantages of tax-deferred and tax-free compounded investment gains that are trademarks of qualified plans.

Financial institutions are not required to set aside funds for these benefits, however, as they are with qualified plans. But companies that do not invest funds for supplemental retirement plans run the risk of incurring large future obligations that would have to be satisfied from future earnings. This is analogous to the Social Security system's functioning: Future workers will pay current workers' retirement income.

Poorly structured nonqualified plans can also lead to negative tax consequences and an immediate impact on earnings. This can occur, for example, when an institution relies too heavily on mutual funds for investments in nonqualified 401(k) accounts. A sharp and unexpected rise in the value of these assets can trigger a tax liability even if executives have not yet retired.

Communicate Effectively

It is also essential for companies to tell their executives of the benefits they will get under the supplemental plan. At least once a year, participants should get a booklet with an individualized summary of benefits and simple but comprehensive overview of the plan. Many financial institutions are also making this information available on a day-to-day basis, via the Internet.

When financial executives are told of the quantity of benefits they will get from a supplemental retirement plan - as well as the quality of the plan - they are more likely to resist tempting job offers that may include sizable pay increases.

Mr. Edelstein is a principal in the Cleveland office of the Todd Organization Inc., a firm that specializes in the design, administration, and financing of non-qualified retirement plans.

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