Reward Key Officers with a 401(k) Look-Alike Plan


compensation-6-15-17.pngCompensation is one of the most effective tools in motivating executives to higher levels of performance. However, in today’s market, the compensation committee and the board have a variety of alternative compensation approaches to select from to most effectively attract, motivate and retain executive talent. Banks are seeking maximum performance from executives while executives are seeking income and, especially, retirement security.

Although most banks do a fully satisfactory job retaining solid performers by paying competitive salaries and bonuses, they are uncertain what to do when it comes to providing something truly special for their top executives while, at the same time, prudently managing expenses to protect the interests of shareholders.

Saving for Retirement
According to the trade association the Insured Retirement Institute, baby boomers are turning age 65 at a pace of roughly 10,000 per day, and if you’re a baby boomer who is fast approaching retirement, you might be wondering if you’re on target with your retirement savings goals.

Compounding the problem are IRS rules requiring no discrimination in favor of higher paid employees. Amounts that can be contributed to qualified retirement plans, such as 401(k) plans, are subject to statutory limits. The 2017 maximum pre-tax contribution is $18,000, with a catch-up contribution limit for employees aged 50 or older of an additional at $6,000. Therefore, qualified benefit plans do not fully meet the financial needs of executives because of their low limit on annual deferrals.

Today, financial planners, advisors, and consultants all seem to agree that retirees should plan for replacing 60 percent to 80 percent of preretirement income during the retirement period. While the right income-replacement ratio is highly dependent on a number of factors, most bank executives will not reach this level without help from nonqualified benefit plans.

401(k) Look-Alike Plan
One way banks can address these limitations is by offering a 401(k) look-alike plan. This nonqualified deferred compensation plan allows a select group of executives to make voluntary deferrals on a pre-tax basis with a matching contribution from the bank. Interest may also be credited to the executives account. Executives defer paying income taxes on money contributed now until retirement, a time when they may be in a lower tax bracket.

By tying the matching contributions to performance benchmarks, such as department and individual criteria, the executive is motivated to achieve higher results. When such plans are properly designed, if the shareholders do well, so will the executives. Note: As with any incentive-based compensation, matching contributions to the 401(k) look-alike plan should not provide executives with incentives to take imprudent risks that are not consistent with the long-term health of the bank.

Deferring income into nonqualified plans does have its disadvantages. For the bank, nonqualified plans—unlike their qualified counterparts—are not favored by a current tax deduction. The tax deduction is delayed until the officer receives the benefit.

There is also risk because nonqualified plans need to remain unfunded to achieve the desired tax deferral. A nonqualified plan must remain just a promise to pay a retirement benefit. It is a liability on the bank’s books and nothing more. In the event of bankruptcy or company takeover, executives in the plan stand to lose some or all of the money in the nonqualified plan.

Summary
Knowing that retirement security is a primary concern of your executives, it may be time for your bank to rethink its approach to executive compensation. By adding a 401(k) look-alike plan, the ability to attract and retain talented executives will be greatly enhanced.

Should our 401(k) Get Married?


CCR_2-8-13.pngRetirement plans are viewed by many bank boards as necessary to retain employees and keep up with the competition. Costs are weighed against benefits, real and perceived. How should private banks and holding companies view their 401(k) while looking to minimize costs and maximize benefits?  One way is to marry the 401(k) provisions with employee stock ownership provisions in a single plan: a 401(k) + Employee Stock Ownership Plan or KSOP.

Should a Retirement Plan Own Closely-Held Shares?

The ability to purchase shares in a closely-held bank or bank holding company using the company’s tax-deductible contributions and dividends does not mean that it is universally the right thing to do.  First, no employee money should be used to purchase stock—funding will be entirely with employer-directed dollars. Efforts to structure programs using employee money to buy private stock are fraught with fiduciary and legal concerns (remember Enron?). Four major strategic considerations in using a qualified plan to purchase shares are:

  1. Is there a need to buy shares back?
  2. Will the required independent valuation of the shares reflect a fair market value acceptable to sellers?
  3. Will the tax favors and incentives of employees having beneficial ownership in some shares in the company warrant the costs?
  4. Does the company have the discretionary earnings to make such purchases, even on an untaxed basis, given the need for capital?

If the conclusion is that the tax-exempt private stock market is appealing, how does the KSOP work?

Key KSOP Operational Features 

A KSOP is a single plan document defining the two major components: 1) The employee savings deferrals making up the employee-directed accounts, and 2) The company contributions and dividends comprising the employer-directed accounts.

All the customary 401(k) features for employees can be retained—i.e. vesting, distribution rules, hardship loans, array of investment choices, daily valuation etc. for the employee directed money. The employer money can now be used to make contributions in cash or stock to the plan, with features of the company stock accounts now reflecting ESOP rules.

For example, if the employer match is made in the form of stock, the matching shares are allocated to all plan participants who participate in the deferral program. This is often done by employers wanting high employee participation. Rules restrict benefits that skew heavily to highly compensated individuals, and this broad participation can allow the more highly-compensated employees to defer more because it allows the firm to pass non-discrimination tests required for these plans.

The usual mechanism of a safe harbor 401(k) plan requires immediate 100 percent vesting of all contributions and employer matching contributions. Contributions can be matched at 3 percent of pay, or dollar for dollar up to 3 percent and then 50 percent on the next 2 percent of pay. The match goes to even non-participating employees.  

We have seen non-safe-harbor matches made with stock to avoid these rules and still provide sufficient incentives for broad participation.

Four Basic Pros:

  1. The company sponsors a single plan, which for companies with more than 100 employees requiring plan audits, reduces the cost to a single audit.
  2. The company can make matching non-cash contributions in the form of stock.
  3. The company can use cash accumulated in the employer-directed accounts to buy shares from any source—even newly-issued stock for capitalization purposes.
  4. As opposed to separate administration of two plans (often by different vendors), the consolidation of the process in a single plan can simplify management of the retirement plan.

Three Basic Cons:

  1. With often different rules for the ESOP and 401(k) components of one plan, care must be taken to avoid participant confusion.
  2. An independent valuation of the employer stock is required—something done annually, as opposed to the typical 401(k) daily valuation platform, which can also be a source of misunderstanding.
  3. The stock will incur an obligation for the company to repurchase shares for cash in the future.

Conclusion

Banks and bank holding companies needing a controlled market for their shares and reduced retirement plan costs, while retaining or improving employee retirement benefits, should consider a marriage allowed in the tax code between 401(k)s and ESOPs. Yes, there are complications, but the IRS will get its pound of flesh, either in complexity or dollars. Choose wisely.