Human Capital & Careers

Shy of Retiring

With split-dollar life insurance and supplemental retirement plans under attack, finance chiefs might face some slightly tarnished golden years.
Lisa YoonOctober 31, 2003

Of all people, CFOs would seem to be among the best at managing their own retirement benefits. Their know-how in gauging corporate costs, estimating investment returns, and forecasting tax implications would seem especially well-suited to figuring out their own future finances.

As it happens, however, they often stumble when financial decisions get personal, say wealth-management and executive-benefits experts. One reason is a problem they share with other senior executives: overabundant busyness. “CFOs tend to have a blind spot for their own money,” says William Fleming, a director at PricewaterhouseCoopers HR Services. “They just don’t have enough time.”

Unique to some CFOs, on the other hand, is the sense that their corporate financial savvy will automatically make them deft handlers of their own retirement plans. That’s the wrong assumption, according to Robert Stolar, head of financial planning at U.S. Trust Corp. “They think personal finance is easy [compared with corporate finance], but it’s not,” he says. “There are a lot of details in areas like tax law and estate tax issues that are very different from corporate finance.”

Yet this is no time for finance executives to be living in a retirement-planning vacuum. On the alert for unmerited executive pay, regulators are scrutinizing a number of compensation tools. The result may be a limited array of retirement-savings options for executives. “The horizon is narrowing, with developments such as Sarbanes-Oxley and stock-options expensing,” says Leonard Wilson, president of executive-benefits consultancy The Todd Organization.

With the Financial Accounting Standards Board pondering a rule change that would make it mandatory for employers to treat stock-options compensation as an expense, for example, many companies are looking for alternatives. (Indeed, for many top-earning CFOs, bonuses have already replaced options as the dominant form of compensation.)

To be sure, the most that participants can contribute to a 401(k) will expand gradually from $12,000 in 2003 to $15,000 in 2006. At the same time, under federal anti-discrimination rules, those earning more than $90,000 at many companies will be able to contribute a good deal less. Employer matching contributions to the accounts of the well-paid are also curbed by anti-discrimination tests. In any event, 401(k) contributions aren’t likely to be high on the list of retirement-savings choices for top earners.

Splitting Up Is Hard to Do

One executive retirement benefit that many experts say is going the way of Enron is the split-dollar life insurance policy. In such arrangements, the employer and employee agree to divvy up the premiums or benefits, or both, of a life insurance policy. In some cases, the executive’s heirs eventually repay premiums to the employer. In others, the company provides life insurance to executives as part of their compensation packages.

Besides a death benefit, such policies often include an “equity” component that is allowed to grow tax-free and that the executive can borrow against. The interest earnings on the equity have enabled many executives to enjoy the benefits of “a fat, juicy life-insurance policy, [without paying] any tax on it,” as PwC’s Fleming puts it.

When executives or their estates reimburse an employer for a split-dollar insurance premium, however, the arrangement can start to look a whole lot like a loan. If it looks enough like one to the Securities and Exchange Commission, the SEC could rule it illegal. Under Section 402 of Sarbox, public companies and bond issuers are barred from bestowing personal loans on executives.

Then there’s the tax issue. In September, the Internal Revenue Service issued rules that would require executives to pay income tax on earnings from split-dollar plans. Considering the inevitable court battles between the IRS and the life-insurance industry, the rules aren’t likely to be implemented for several years, Fleming thinks.

But executives would do well to act now. For some, the cost of waiting too long and receiving a negative IRS tax judgment could be severe, the PwC consultant says. Depending on the amount of cash value the executive accumulates on the plan, the income tax owed could amount to millions.

To be sure, there are some escape hatches. One is to take advantage of the IRS’s “termination before 2004” rule: End split-dollar arrangements before 2004, and tax penalties are forgiven. Companies could also replace split-dollar arrangements with other kinds of cash-value life insurance or provide a death-benefit-only plan — a less favorable deal in which beneficiaries would have to pay income taxes.

SERPs Perps

Facing strict limits on 401(k) plan contributions and potential curbs on split-dollar arrangements, companies are increasingly turning to supplemental vehicles to retain and attract talented executives. Surveys by executive-benefits consultancies Clark Consulting and The Todd Organization suggest that more and more employers companies are using supplemental executive retirement plans (SERPs) to extend benefits for executives.

But here, too, the choices may be narrowing. Mirroring the broader corporate movement away from defined-benefit (DB) pension plans to defined-contribution (DC) plans like 40(k)s, employers are switching from DBs to DCs on the SERPs front, benefits advisors say. “Ten years ago I would have said less than 5 percent of my clients had DC SERPs,” says Joe Hessenthaler of Towers Perrin’s retirement benefits practice. “Now it’s more like 15 to 20 percent.”

The trend represents a shift of risk from employers to executives. In a DB SERP, the employer adds set amounts to an executive’s other benefits according to a formula, such as a percentage of the executive’s final average pay. The guesswork involved in determining the final earnings of executives and their years of service can entail some anxiety-provoking volatility for an employer. In contrast, in a SERP DC, the employer promises to credit an interest-paying account with a percentage of an employee’s current salary.

Besides the actuarial challenges, there’s another reason for the slow but sure move by employers away from DB SERPs: to avoid the appearance of executive greed. “Many companies don’t have defined-benefit plans for the rank-and-file [usually it’s cash balance or 401(k) plan],” he says. “In that case, it doesn’t look good for executives to have defined-benefit SERPs.” (Read more about the growing public backlash against special retirement plans for executives.)

With executive retirement benefits under attack from a number of sides, it might not be a bad idea for a CFO who can afford it to put together a team of advisers. Both Fleming and Stolar — advisers themselves — say the team should consist of at least three experts: an attorney, a tax preparer, and an investment advisor. Still, having a personal finance team doesn’t mean they should control the money. Says Stolar: “Finance executives must manage the team as they would manage their finance departments.”