Deferred compensation could be next casualty, advisers fear

Deferred-compensation plans, one of the last ways for middle-level managers to save enough money for retirement, may be marked for extinction.

That’s the chief concern of financial advisers and other business organizations as the Senate Finance Committee this week gears up for hearings on executive compensation.

Worried about abuses that came to light in the Enron Corp. debacle involving deferred-compensation plans for executives, Republicans and Democrats in both houses of Congress are considering limits that could effectively kill the plans.

Many financial advisers counsel their high-paid clients to use such plans to enable them to save enough money for retirement. Without the plans, they say, it would be much more difficult for their clients to accumulate enough wealth to maintain their lifestyle when they stop working.

“The problem that we have right now is the inability to really set enough money aside for one’s retirement,” says Roger Smith, president of Planned Solutions Inc. in Sacramento, Calif.

Mr. Smith, a certified financial planner whose firm manages about $100 million, says he has seen good uses of deferred-compensation plans, as well as abuses.

He recalls a client three years ago whose Fortune 500 company guaranteed a 15% annual return for a deferred-compensation plan for its top 10 senior executives.

“Now, how do you do that?” Mr. Smith asks. “What it meant was that money’s got to come out of corporate coffers. What it’s saying is, the company is piling 15% on top of their deferred compensation, which is not reported.”

His client amassed $1.4 million under the plan, he says.

But another client, who was a vice president for a publicly traded retail company, would have had much less money left for retirement had he not had about $300,000 in a deferred-compensation plan, Mr. Smith says.

That client was pressured into moving the assets that had been in the company’s 401(k) plan into company stock about five years ago, he says. That stock, then worth approximately $500,000, is now worth less than $18,000, Mr. Smith says.

Mr. Smith would not reveal the companies in- volved in either case.

It is situations such as the case of the first client that have attracted the attention of many in Congress, who are looking at whether such policies should effectively be banned.

Senate Finance Committee Chairman Charles Grassley, R-Iowa, is planning to reintroduce legislation that was approved by the committee last year.

Among other things, the legislation would repeal a moratorium imposed on the Internal Revenue Service in 1978 that prevents the agency from issuing new regulations on deferred-compensation plans.

The proposal is included in President Bush’s budget plan for fiscal 2004.

Corporate lobbyists are concerned that such repeal would lead to regulations that would make it more difficult to use deferred-compensation plans.

The House Ways and Means Committee also will be reintroducing legislation dealing with tax issues connected to foreign trade that will likely include new tax treatment of deferred-compensation plans.

A bill introduced last year by Chairman William Thomas, R-Calif., would have required immediate taxation on almost every form of deferred-compensation arrangement, which would have effectively killed such plans. Rep. Robert Matsui, D-Calif., proposed the provision.

The committee did not vote on the bill last year, and Mr. Thomas is expected to revise the legislation before reintroducing it this year.

Lynn Dudley, vice president of retirement policy for the American Benefits Council, a Washington organization representing Fortune 500 companies, says that many middle managers now have deferred-compensation plans.

Ms. Dudley says such plans have grown since 1993, when Congress capped tax-deductible corporate executive pay at $1 million. Since most leaders of big corporations are paid far more than that, companies have come up with new ways to compensate them. Congress’ Joint Committee on Taxation recommends reconsidering the tax deduction limit.

The other reason for the growth in the deferred-compensation plans is the relatively low contribution and payout limits for other types of tax-advantaged retirement plans, such as 401(k) plans, Ms. Dudley says. This year, contributions by 401(k) plan participants are limited to $12,000.

“This affects people at the $90,000-$125,000 income range,” Ms. Dudley says. “There are way more people in those income ranges participating in these [deferred-compensation] plans than have ever participated in them before, because they cannot prepare adequately for retirement in the qualified [tax-advantaged] plan system.”

While deferred-compensation-plan participants do not pay taxes on the money deferred, companies do not get a tax break for the contributions. In addition, Ms. Dudley notes, the money is susceptible to going to creditors in the event that the company goes bankrupt.

One provision expected to be in the Ways and Means Committee bill will likely significantly limit the ability of companies to allow their managers to take penalties voluntarily in order to get early distributions from their deferred-compensation plans, a provision known as a “haircut.”

Enron executives reportedly took haircuts to get money out of their plans early as the company was going down the tubes financially.

Ms. Dudley says that such provisions are typically used by middle managers. “I don’t know that corporate America thinks they’re so invaluable that they can’t live without them,” she says. “But they do typically impact the middle management more than other people, and corporations are going to need some time to readjust their arrangement. They’re going to have to renegotiate their arrangements with people. People have expectations.”

Barbara Steinmetz, a CFP and enrolled agent who owns Steinmetz Financial Planning in Burlingame, Calif., believes that deferred compensation will be tarred with the same brush that is currently making stock options so unpopular among investor activists and market critics.

Ms. Steinmetz’s firm, which counts many Silicon Valley executives among its clients, manages about $14 million. She says she is trying to convince her clients to use deferred-compensation plans more.

“I’m trying to get them to look at this as a potential retirement planning tool,” she says. “The driving force for most of them is the fear of having to pay Uncle Sam now.”

Related Topics: Deferred Compensation