Long-Term Incentives and Wealth Building

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Long-Term Incentivesand Wealth Building

• For most employees, their long-term security
  needs are provided for by
• Social security
• Their employer's retirement plan

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Long-Term Incentivesand Wealth Building

• For most employees, their long-term security
  needs are provided for by
• The continuation of their employer's medical and
  insurance plans (and for a small group of
  employees).
• Employer-provided long-term compensation
  arrangements.

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Wealth and Work in the United States

• The majority of the wealthy in this country did
  not acquire their wealth through inheritance.
• It was accumulated through earnings.

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WEALTH AND WORK IN THE UNITED STATES

• Savings, wisely invested and tax deferred,
  coupled with valuable, company paid and tax free
  benefits, provide ordinary workers an opportunity
  to accumulate wealth.....

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WEALTH AND WORK IN THE UNITED STATES

• For those in more lofty positions of power within
  most organizations, the opportunities for wealth
  building are "remarkable".

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Tax Legislationand Long-Term Incentives

• Federal tax law and long-term compensation
  practices are inextricably joined, (sometimes
  dysfunctionally), but more often than not the
  relationship has been constructive, and
  economically rational.

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Tax Legislationand Long-Term Incentives

• Over the years Congress has used tax legislation
  to promote both individual and corporate behavior
  by
• Providing a wide variety of deductions and
  credits to corporate and individual income tax
  obligations.

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Tax Legislationand Long-Term Incentives

• And
• Promoting individual security and enhancing the
  lifestyles of all workers and their dependents.

9
Fixed and VariableLong-Term Compensation

• The most common arrangements for long-term
  compensation have been those that provide
  retirement programs to supplement federal social
  security benefits.
• Additionally, many of these long-term
  compensation plans involve the deferral of a
  certain amount of current pay until retirement.

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Three Types Of Deferred Plans

• Qualified Deferred
• Capital Accumulation
• Other Deferred and Supplemental Retirement Income
  Arrangements

11
Qualified Deferred Plans

• Plan qualification requirements are defined under
  section 401(a) of the Internal Revenue Code and
  the term qualified can relate to a variety of
  employer-offered benefits.

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Qualified Deferred Plans

• Qualified, as it relates to pension, profit
  sharing, and stock bonus plans, permits the
  employer to deduct all contributions to such
  plans in the year the contribution is made, and
  none of the employer's contribution is treated as
  employee taxable earnings until the employee
  receives the distribution.

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"To Be Qualified"

• The plan must be in writing.
• The employee's rights under the plan must be
  legally enforceable.
• The employer must intend to maintain the plan
  indefinitely.
• The employer must provide for reasonable
  notification to employees of benefits under the
  plan.

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"To Be Qualified"

• The plan must be maintained for the exclusive
  benefit of the employees.
• The plan must be funded.
• The plan must be nondiscriminatory - it cannot
  discriminate in favor of shareholders, officers,
  or highly compensated employees.

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"To Be Qualified"

• Contributions and benefits covered by the plan
  must become non-forfeitable according to
  prescribed requirements.

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Qualified Deferred Plans

• Social Security
• Employer-Provided Retirement
• Savings or Thrift
• Cash or Deferred Arrangement (Coda)- 401 (K).
• SEP's and Keogh's
• Continuation of Employer-Provided Health and
  Medical Insurance.

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Social Security

• More than 60 of all retirees depend on SS for
  over one half of their retirement income.

60
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Qualified Retirement Plans

• About 50 of the non-farm U.S. workforce receive
  some form of retirement protection from employers
  through either
• Private Pension
• Deferred Profit Sharing
• Stock Bonus Plans

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Private Pension Plans

• Defined Benefit Plan
• Includes a formula that defines the benefits an
  employee is to receive.
• Defined Contribution Plan
• Involves the payment of a specified annual amount
  to the account of each participant.

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Pension Plans

• All pension plans are concerned with the
  following five basic issues
• Standard Retirement Age
• Size Of Benefit
• Discrimination In Plan Design
• Early Retirement
• Vesting

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Profit Sharing Plans

• The employers contributions to the plan are a
  percentage of corporate profits.
• There is no required contribution but employers
  must make substantial and recurring contributions
  to meet requirements.

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Profit Sharing Plans

• These plans are not usually set up with
  retirement income in mind, and as a consequence
  the normal method of distribution is lump-sum
  payment.

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Stock Bonus Plan

• Employer contributes stock to the plan.
• The actual allocation among participants depends
  on the same requirements as a defined benefits
  and a defined profit sharing plan, although the
  plan functions like a defined contribution plan.

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Plan Limitations

• There is a limit on the level of pay that can be
  taken into account... Appropriate discounts for
  early retirement...Special provisions for
  survivors...Etc.

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Employee Stock Ownership Plan

• A defined contribution plan that operates like a
  qualified stock bonus plan. (TRASOP'S and
  PAYSOP'S were discontinued in 1986).

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Savings or Thrift Plans

• Possibly the most commonly provided defined
  contribution plan.
• Over the years many employers have developed
  savings or thrift plans that encourage employees
  to set aside certain amounts of earnings in order
  to have a more secure retirement.

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Savings or Thrift Plans

• An employee can contribute up to 6 of eligible
  annual compensation on either a before or after
  tax basis with all or a portion of this amount
  matched by the employer.
• As a general practice the employee is given a
  number of investment options to which his or her
  funds can be directed.

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SAVINGS OR THRIFT PLANS

• All earnings in these plans are tax deferred
  until the funds are distributed to the
  participant.

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401 (K) Cash or Deferred Arrangement (CODA)

• The major feature of a 401 (k) plan is that
  employees have the right to agree to a reduction
  in salary in exchange for a comparable employee
  contribution to a qualified trust.
• The amount of deferred and accumulated earnings
  are excluded from current income and are taxed
  only when distributed.

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SepSimplified Employee Pension Plan

• Restricted to employers with less than 26
  employees. They are restricted to most of the
  same restrictions applicable to any qualified
  plan.

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Keogh Plans

• Self-Employment Plans

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Capital Accumulation

• Equity-Based Programs
• Provides employees (usually key executives) with
  an opportunity to acquire stock in their
  employer's corporation.
• Almost all large corporations provide long-term
  incentives for their executives with stock
  options the most common type of award.

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Capital Accumulation

• Long-term Bonuses
• Plans designed to provide awards that are earned
  over a specific period of time - anywhere from 2
  to 5 to as high as 10 years into the future..

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Capital Accumulation

• Insiders - Outsiders
• The securities and exchange commission (sec)
  issues regulations regarding the communication
  and the acquisition of stock by certain key
  personnel.

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Capital Accumulation

• The key personnel are the five most highly
  compensated executives and their cash
  compensation must be documented on corporate
  proxy statements, registration statements, and
  periodic reports .

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Capital Accumulation

• The SEC defines "insiders" as officer, directors,
  and those individuals holding 10 percent or more
  of the stock in the corporation, and....
• They must disclose their stock ownership and
  provide monthly reports of changes in amount of
  ownership.

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Other Deferred and Supplemental Retirement
Income Arrangements

• A major issue that must be addressed by most
  organizations is the pension plan payments to
  highly compensated employees.
• ERISA places a limit on pension payments (as of
  1993) of 115,641. Highly paid employees
  normally earn a higher retirement benefit than
  that allowed by ERISA.

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TO OVERCOME THIS PROBLEM MANY ORGANIZATIONS HAVE
DEVELOPED "ERISA EXCESS BENEFIT PLANS" TO KEEP
THE HIGHLY PAID EXECUTIVES "WHOLE".
Other Deferred and Supplemental Retirement
Income Arrangements

• To overcome this problem many organizations have
  developed ERISA excess benefit plans" to keep
  the highly paid executives "whole".
• Supplementary executive retirement plans (SERPs)
  have since improved on and consumed the "excess
  benefit plans" providing an even more attractive
  benefit to the highly compensated executives.

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Other Deferred And Supplemental Retirement
Income Arrangements

• SERPs are unfunded, non-qualified retirement
  plans. Payments come out of general company
  assets or company-owned life insurance trusts.
• Additionally, SERPs can and do provide retirement
  benefits that are more generous than those
  provided the rest of the workforce.

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Executive CompensationObscene or Motivational

• Base salary
• Short-Term bonuses
• Equity and equity related components (stock
  ownership)
• Long-Term performance bonuses
• Severance packages
• Supplemental retirement programs
• Special benefits and perquisites

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Executive CompensationObscene or Motivational
Executive Perks

• Company Car, Parking
• Club Membership
• Chauffeured Limousine
• Counseling Service

• Spouse Travel
• Use of Company Plane / Yacht
• Home Entertainment Allowance
• Special Living Accommodations

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Executive CompensationObscene or Motivational
Executive Perks

• Special Dining Rooms
• Company Credit Cards
• Medical Expense Reimbursement

• No-and-low Interest Loans
• College Tuition Reimbursement For Children