Pension Plans To Fund Executive Benefits
Little-Known Move Uses Tax Break Meant For Rank and File
The Wall Street Journal
By Ellen E. Schultz and Theo Francis
Monday, August 4, 2008
At a time when scores of companies are freezing pensions for
their workers, some are quietly converting their pension plans
into resources to finance their executives' retirement benefits
In recent years, companies from
Inc. collectively have moved hundreds of millions of dollars of
obligations for executive benefits into rank-and-file pension
plans. This lets companies capture tax breaks intended for
pensions of regular workers and use them to pay for executives'
supplemental benefits and compensation.
The practice has drawn scant notice. A close examination by The
Wall Street Journal shows how it works and reveals that the
maneuver, besides being a dubious use of tax law, risks harming
regular workers. It can drain assets from pension plans and make
them more likely to fail. Now, with the current bear market in
stocks weakening many pension plans, this practice could put
more in jeopardy.
How many is impossible to tell. Neither the Internal Revenue
Service nor other agencies track this maneuver. Employers
generally reveal little about it. Some benefits consultants have
warned them not to, in order to forestall a backlash by
regulators and lower-level workers.
The background: Federal law encourages employers to offer
pensions by giving companies a tax deduction when they
contribute cash to a pension plan, and by letting the money in
the plan grow tax free. Executives, like anyone else, can
participate in these plans.
But their benefits can't be disproportionately large. IRS rules
say pension plans must not "discriminate in favor of highly
compensated employees." If a company wants to give its
executives larger pensions -- as most do -- it must provide
"supplemental" executive pensions, which don't carry any tax
The trick is to find a way to move some of the obligations for
supplemental pensions into the plan that qualifies for tax
breaks. Benefits consultants market sophisticated techniques to
help companies do just that, without running afoul of IRS rules
against favoring the highly paid.
Intel's case shows how lucrative such a move can be. It involves
Intel's obligation to pay deferred compensation to executives
when they retire or leave. In 2005, the chip maker moved more
than $200 million of its deferred-comp IOUs into its pension
plan. Then it contributed at least $187 million of cash to the
Now, when the executives get ready to collect their deferred
salaries, Intel won't have to pay them out of cash; the pension
plan will pay them.
Normally, companies can deduct the cost of deferred comp only
when they actually pay it, often many years after the obligation
is incurred. But Intel's contribution to the pension plan was
deductible immediately. Its tax saving: $65 million in the first
year. In other words, taxpayers helped finance Intel's executive
Meanwhile, the move is enabling Intel to book as much as an
extra $136 million of profit over the 10 years that began in
2005. That reflects the investment return Intel assumes on the
Fred Thiele, Intel's global retirement manager, said the benefit
was probably somewhat lower, because if Intel hadn't contributed
this $187 million to the pension plan, it would have invested
the cash or used it in some other productive way.
The company said the move aided shareholders and didn't hurt
lower-paid employees because most don't benefit from Intel's
pension plan. Instead, they receive their retirement benefits
mainly from a profit-sharing plan, with the pension plan serving
as a backup in case profit-sharing falls short.
The result, though, is that a majority of the tax-advantaged
assets in Intel's pension plan are dedicated not to providing
pensions for the rank and file but to paying deferred
compensation of the company's most highly paid employees,
roughly 4% of the work force.
On the Hook
And taxpayers are on the hook in other ways. When deferred
executive salaries and bonuses are part of a pension plan, they
can be rolled over into an Individual Retirement Account --
another tax-advantaged vehicle.
Intel believes that its practices "feel consistent" with both
the spirit and letter of the law that gives tax benefits for
Intel may be a model for what's to come. Many companies are
phasing out their pension plans, typically by "freezing" them,
i.e., ending workers' buildup of new benefits. This leaves more
pension assets available to cover executives' compensation and
supplemental benefits. A number of companies have shifted
executive benefits into frozen pension plans.
Technically, a company makes this move by increasing an
executive's benefit in the regular pension plan by X dollars and
canceling X dollars of the executive's deferred comp or
CenturyTel, for instance, in 2005 moved its IOU for the
supplemental pensions of 18 top employees into its regular
pension plan. Chief Executive Glen Post's benefits in the
regular pension plan jumped to $110,000 a year from $12,000. A
spokesman for the
Monroe, La., company, which made more such transfers
in 2006, was frank about its motive: to take advantage of tax
breaks by paying executive benefits out of a tax-advantaged
How They Do It
So how can companies boost regular pension benefits for select
executives while still passing the IRS's nondiscrimination
tests? Benefits consultants help them figure out how.
To prove they don't discriminate, companies are supposed to
compare what low-paid and high-paid employees receive from the
pension plan. They don't have to compare actual individuals;
they can compare ratios of the benefits received by groups of
highly paid vs. groups of lower-paid employees.
Such a measure creates the potential for gerrymandering --
carefully moving employees about, in various theoretical
groupings, to achieve a desired outcome.
Another technique: Count Social Security as part of the pension.
This effectively raises low-paid employees' overall retirement
benefits by a greater percentage than it raises those of the
highly paid -- enabling companies to then increase the pensions
of higher-paid people.
Indeed, "it is actually these discrimination tests that give
rise to Qserp in the first place!" said materials from one
Watson Wyatt Worldwide.
"Qserp" means "qualified supplemental executive retirement plan"
-- an industry term for a supplemental executive pension that
"qualifies" for tax breaks.
Watson Wyatt senior consultant Alan Glickstein said the firm's
calculations tell employers exactly how much disparity they can
achieve between the pensions of highly paid people and others.
"At the end, when the game is over, when the computer is cooling
off, you know whether you passed [the IRS nondiscrimination
tests] or not," he said. At that point, companies can retrofit
the benefits of select executives, feeding some into the pension
They can do this even if they freeze the pension plan, because
executives' supplemental benefits and deferred comp aren't based
on the frozen pension formula.
Generally, only the executives are aware this is being done.
Benefits consultants have advised companies to keep quiet to
avoid an employee backlash. In material prepared for employers,
Robert Schmidt, a consulting actuary with
Inc., said that to "minimize this problem" of employee
relations, companies should draw up a memo describing the
transfer of supplemental executive benefits to the pension plan
and give it "only to employees who are eligible."
The IRS was also a concern for Mr. Schmidt. He advised employers
that in "dealing with the IRS," they should ask it for an
approval letter, because if the agency later cracks down, its
restrictions probably won't be retroactive.
"At some point in the future, the IRS may well take the
position" that supplemental executive pensions moved into a
regular pension plan "violate the 'spirit' of the
nondiscrimination rules," Mr. Schmidt wrote. In an interview, he
confirmed his written comments.
Companies don't explicitly tell the IRS that an amendment is
intended to shift supplements executive benefits obligations
into the regular pension plan. "They hide it," a Treasury
official said. "They include the amendment with other
amendments, and don't make it obvious."
With too little staffing to check the dozens of pages of
actuaries' calculations, the IRS generally accepts the
companies' assurances that their pension plans pass the
discrimination tests, the official said.
"Under existing rules, there's little we can do anyway. If
Congress doesn't like it, it can change the rules." To halt the
practice, Congress would have to end the flexibility that
companies now have in meeting the IRS nondiscrimination tests.
A spokesman for the IRS said it has no idea how many such
pension amendments it has approved or how much money is
Sometimes, the only tipoff that a firm is moving executive
benefits into the regular pension is that it provides small
increases to some lower-paid groups in the plan, in order to
pass the nondiscrimination tests.
Royal & SunAlliance, an insurer, sold a division and laid off
its 228 employees in 1999. Just before doing so, it amended the
division's pension plan to award larger benefits to eight
departing officers and directors. One human-resources executive
got an additional $5,270 a month for life.
But to do this and still pass the IRS's nondiscrimination tests,
the company needed to give tiny pension increases to 100
lower-level workers, said the company's benefits consultant,
PricewaterhouseCoopers. One got an increase of $1.92 a month.
Joseph Gromala, a middle manager who stood to get $8.87 more a
month at age 65, wrote to the company seeking details about
higher sums other people were receiving. A lawyer wrote back
saying the company didn't have to show him the relevant
Mr. Gromala then sued in federal court, claiming that
administrators of the pension plan were breaching their duty to
operate it in participants' best interests. The company replied
that its move was a business decision, not a pension decision,
so the fiduciary issue was moot. The Sixth U.S. Circuit Court of
PricewaterhouseCoopers declined to comment. A spokesman for
Royal & SunAlliance's former
operation, now called Arrowpoint Capital, said the pension plan
"wasn't discriminatory." Royal & SunAlliance recently changed
its name to
RSA Insurance Group.
Pension-plan amendments like the documents Mr. Gromala sought
must be filed with the IRS, but the agency normally won't
disclose specifics such as who benefits. The IRS says it can't
release details of the amendments because they reflect
Not So Safe
Employers sometimes tell executives that moving their
supplemental pensions or deferred comp into the company pension
plan will make them more secure. Normally, supplemental pensions
or deferred comp are just unsecured promises; companies don't
set aside cash for supplemental executive pensions and deferred
comp because there's no tax break for doing so. But the promises
will be backed by assets if the company can squeeze them into a
tax-advantaged pension plan.
This supposed security can prove illusory, as executives at
Consolidated Freightways found out.
The trucking firm moved most of its retirement IOUs for eight
top officers into its pension plan in late 2001. It said this
would protect most or all of their promised benefits, which
ranged up to $139,000 a year.
This came as relief to Tom Paulsen, then chief operating
officer, who says he knew the
Vancouver, Wash., trucking company was on "thin ice."
But the pension plan was underfunded. And Consolidated didn't
add more assets to it when the company gave the plan new
obligations. Adding the executive IOUs thus made the plan
weaker. It went from having about 96% of the assets needed to
pay promised benefits to having just 79%.
Consolidated later filed for bankruptcy and handed its pension
plan over to a government insurer, the Pension Benefit Guaranty
Corp. The PBGC commits to paying pensions only up to certain
limits. Mr. Paulsen said he and other executives have been told
they won't get their supplemental pensions.
Some lower-level people will lose benefits, too. Chester
Madison, a middle manager who retired in 2002 after 33 years,
saw his pension fall to $20,400 a year from $49,200. Mr.
Madison, 62, has taken a job selling flooring in Sacramento, Calif.
He faults those who made the pension decisions. "I look at it as
greed and taking care of the top echelons," he says.
It's impossible to know how much the addition of executive
pensions to the pension plan contributed to the plan's failure.
But in this as in similar companies where a plan saddled with
executive benefits failed -- such as at kitchenware maker Oneida
Ltd. in upstate New
York -- it's clear the move weakened the
plans by adding liabilities but no assets.
A trustee for Consolidated's bankruptcy liquidation declined to
discuss details of the company's pension plan.
Mr. Madison and five other ex-employees sued Towers Perrin, a
consulting firm that had advised Consolidated on structuring its
benefits. The suit, alleging professional negligence over this
and other issues, was dismissed in late 2006 by a federal court
in the Northern District of California. Towers Perrin declined
Some companies, after moving executives' supplemental benefits
into a pension plan, now take steps to protect them. When
Corp. added executive obligations to its pension plan last year,
it set up a trust that automatically would be funded if the plan
Glenn Morgan, the clothier's chief financial officer, said the
trust benefits nine or 10 people. "The purpose is to pay them
the benefit they've earned," he said.
to Ellen E. Schultz at
firstname.lastname@example.org and Theo