Enhancing Executive Retirement Security: Solutions for Tomorrow

1. “START" - Save Today and Retire TomorrowSolutions to Enhance Retirement Securityfor ExecutivesErik PienkosSenior ManagerBenefits Consulting Practiceerik.pienkos@gt.com

2. Background • Survey data indicates that the typical level of retirement income for executives at age 65 is a minimum of 50% of final average salary (FAS): • A significant percentage of companies provide for higher levels of retirement income (60% of FAS or higher) • Most companies use a final 5-year measurement period for benefit determination purposes: • A significant percentage use a final 3-year measurement period • A "career" threshold for analyzing retirement benefits for rank-and-file employees tends to be longer (generally 30 or more years): • Many companies design executive retirement programs to provide the targeted level of retirement income using a shorter service threshold (generally 15 to 20 years or less)

3. Background (cont'd) • Qualified retirement plans (pension plans, 401(k) plans, etc.) are generally not designed to maximize benefits for executives: • Fewer companies maintain pension plans today • Low participation by non-highly compensated employees (NHCEs) will impact 401(k) contributions by executives • Deferrals capped at $16,500 in 2009/2010 • Testing failures result in refunds to executives • There are many reasons why companies examine various alternatives to provide greater levels of retirement income for executives: • IRS limits on qualified retirement plan benefits • Need to provide incentives to attract, retain and motivate key personnel • Desire to provide targeted level of retirement income for executives

4. Potential Plan Design Solutions • Dual (mirror) plan design • Automatic enrollment • Safe harbor plan designs: • Traditional plan • New automatic enrollment plan (effective 2008) • Roth 401(k) feature • Cross-tested "comparability" plans • Multiple plan design • Nonqualified retirement plans

5. Dual (Mirror) Plan Design • Create a separate mirror 401(k) plan similar to the original plan • Move low participation employees (non-highly compensated employees only) into the mirror plan: • Do not cover any highly compensated employees (HCEs) in the mirror plan • Mirror plan and original plan must separately pass plan coverage test: • Will need to monitor plan coverage levels carefully • Use of nondiscriminatory classification test provides flexibility • Depending upon the mix of NHCEs and HCEs, percentage of NHCEs that can be moved into the mirror plan can be significant • Original plan should have significantly better test results: • Greater pre-tax deferrals will be allowed for HCEs • Will result in higher levels of accumulation for executives in the plan

6. Automatic Enrollment • Consider use of automatic enrollment feature to increase NHCE participation rates: • Will help improve nondiscrimination test results (fewer zeros in test) • HCEs will benefit but will increase company's matching contribution commitment • Can limit automatic enrollment feature to new hires only or can also have it cover current eligible employees who are not making pre-tax deferrals • Need to consider administrative implications of automatic enrollment: • Employees can opt out once they are automatically enrolled • Potentially creates lots of small recordkeeping accounts, so plan administration costs may increase

7. Safe Harbor Plan Designs • Traditional safe harbor plan: • Level of company contributions • Vesting • New automatic enrollment safe harbor plan design (2008): • Automatic enrollment levels • Level of company contributions • Vesting • Safe harbor plan design will maximize the ability of executives and other HCEs to make pre-tax deferrals: • No special nondiscrimination testing for the plan • Automatic enrollment safe harbor will help retirement accumulations for NHCEs (but will also increase contribution costs and plan administration costs for employer)

8. Roth 401(k) Feature • 401(k) plans can allow employees to designate all (or portion) of elective deferrals as after-tax Roth deposits: • Generally treated the same way as pre-tax deferrals: • Same IRS limit applies ($16,500 in 2009/2010) • No double dipping with both pre-tax deferrals and Roth after-tax contributions • Treated as elective deferrals under ADP test • Earnings are not currently taxed to employees • Distributions are not taxed if certain requirements met • Better than employee pre-tax contributions if income tax rates rise in future years: • Serves as hedge against future income tax increases

9. Cross-tested "Comparability" Plans • Allows for enhanced contribution levels for a select group of management: • Takes advantage of qualified plan nondiscrimination rules to design plans that can provide significantly higher annual benefits • Test defined contribution plan (401(k) plan or profit sharing plan) like a defined benefit pension plan • Annual allocation based upon "class" (such as job description, etc.) • May eliminate or reduce the need for nonqualified plan: • Eliminates a potential 409A compliance issue • Result: Targeted executives can receive substantial annual contributions at or near the IRS annual plan limit ($49,000 in 2009/2010)

10. Multiple Plan Design • Implement a two-plan structure that targets older executives: • Defined benefit pension plan will cover certain HCEs (generally older ones) and limited number of NHCEs (generally younger ones) • Remainder of eligible employees will stay in the 401(k) plan • Will need to monitor plan coverage and, more importantly, minimum participation requirements so that there is sufficient NHCE coverage in the defined benefit pension plan: • Number of NHCEs in pension plan will depend upon size of eligible workforce and mix of HCEs and NHCEs • Minimizes opportunity to only cover executives in the pension plan • Goal is to maximize the employer contributions in the pension plan for the older HCEs: • Will generally mean that older executives receive employer contributions in excess of amounts permitted under the 401(k) plan rules

11. Nonqualified Retirement Plans • Complete employer discretion as to plan design, covered group of executives, level of benefits, key features, etc. • Employees generally not taxed until amounts are received: • Employer takes income tax deduction as the same time • Can provide benefits in excess of qualified plan limitations and can base benefits on compensation in excess of IRS pay cap for qualified plans ($245,000 in 2009/2010): • Many nonqualified plans are "linked" with qualified plans • Benefits generally not funded so executives are unsecured creditors • Need to make sure that plans comply with new deferred compensation rules under IRC 409A: • Generally should not be a compliance problem • In event of noncompliance, 20% excise tax assessed on executives

12. Example – How START can work • ABC maintains a “garden variety” 401(k) plan for all employees • On track to fail ADP/ACP testing for the third year in a row • Executives and other highly-compensated employees will be getting refunds of $3-4K each • Employee communication efforts have not led to increased NHCE deferrals • One solution – go with safe harbor design coupled with class allocation profit sharing feature • Executives grouped into classes (perhaps top execs in Class A and other key management in Class B) • 3% safe harbor contribution provided to NHCEs to allow plan to escape ADP/ACP testing • Additional, discretionary annual profit sharing contribution can be made to NHCEs to allow for larger exec contributions • Class A execs targeted to max out at $49K total contribution • Class B members targeted for 12% of pay contribution

13. Evaluation Process • Review current qualified plan design and projected level of benefits for executives under various assumptions at different retirement ages • Identify employer's goals for executive benefits, including cost constraints • Analyze various plan designs (both qualified plan and nonqualified plan): • Level of benefits • Costs (including any incremental qualified plan costs) • Nondiscrimination test results (if required based on plan design) • Recommend plan design(s) that meet employer's goals • Agree on final plan design • Implement enhanced plan(s) • Communicate with affected individuals

14. Supplemental Unemployment Benefit (“SUB”) PlanProviding Tax-Efficient Severance Benefits

15. Overview of SUB Plan Idea • SUB plan can be used to provide income to laid-off workers to supplement their state unemployment compensation benefits • Severance payments from a SUB plan that are intended to supplement the receipt of state unemployment benefits are not considered "wages" for employment tax purposes

16. Overview of SUB Plan Idea (cont'd) • The SUB Plan allows payment of periodic (not lump-sum) unemployment benefits free of FICA and FUTA • Payments received by employees under a SUB Plan are likewise not subject to FICA withholding • Payments made by the SUB Plan do not disqualify the employee from state unemployment compensation benefits

17. Key Requirements • Benefits are paid only to unemployed former employees who are laid off (e.g., an involuntary separation from service) • Employees are eligible to receive benefits under the SUB Plan only if they apply for and receive state unemployment benefits • Amount of benefits payable is based upon the employee's state unemployment benefits and his/her rate of straight-time pay

18. Key Requirements (cont'd) • Employees must receive benefits periodically (e.g., weekly or according to their frequency of pay when employed): • No benefits can be payable in a lump sum • Company must monitor and track employee eligibility for state unemployment benefits: • SUB Plan payments must stop when employee is re-employed

19. Timing • Prospective application only: • Layoffs commenced – not viable; mid-stream change difficult • Layoffs announced – need time to implement strategy (minimum 1 to 2 months)

20. Impact on Company and Affected Former Employees • Implementation of SUB Plan may result in significant tax savings to both company and its former employees: • Worker receives $5,000 in severance payments periodically before re-employment • FICA tax savings alone are approximately $380 for both company and former employee (assumes FICA tax rate of 7.65%)

21. Welfare Benefit Trust Funding • Can optionally fund the SUB Plan through a tax-exempt welfare benefit trust (IRC Section 501(c)(17)) • Use of trust may allow company to fund and deduct contributions to trust in year made and have trust earn income on assets free of taxation

22. Implementation Planning – Key Steps • Determine severance plan parameters, eligibility requirements and other SUB Plan design and administration issues • SUB Plan feasibility assessment: • Number of affected employees • Severance levels • Potential FICA tax savings • Trust funding strategy • Implementation and administration costs

23. Implementation Planning – Key Steps (cont'd) • Develop template for plan document for drafting by legal counsel • Prepare employee communication materials • Assess internal vs. external administration capabilities • Coordinate ongoing administrative responsibilities: • Monitor compliance with SUB Plan requirements so FICA tax savings are generated