Private Pensions

To raise private savings for workers' retirement, federal law provides tax incentives for contributions to pension plans. Company sponsors of private defined benefit (DB) pension plans can claim a tax deduction for their contribution amount to a tax-qualified pension plan, and employees' taxes on contributions and investment earnings are deferred until they retire and start receiving benefit payments. To achieve and maintain tax-qualified status, DB plans must comply with multiple federal requirements that are designed to ensure that executives and other highly compensated employees (HCE) do not receive excessively high benefits, both in an absolute sense and relative to nonhighly compensated employees (NHCE). These include limits on total benefit levels, limits on the amount of compensation that can be included in determining benefit levels, and limits on disparities in benefits between HCEs and NHCEs. The goal of the nondiscrimination requirements is to encourage expanded coverage and greater distribution of benefits between the highly paid and workers at lower earnings levels. To demonstrate compliance, plan sponsors may use an IRS preapproved plan or develop a customized plan, which must pass general nondiscrimination tests. These tests generally require a plan sponsor to perform mathematical calculations that compare the proportion of NHCEs who benefit under a tax-qualified plan with the proportion of HCEs who benefit, taking into account their respective benefit accrual rates. Due to the restrictions placed on benefits in a tax-qualified plan, some private sponsors of tax-qualified retirement plans provide additional nontax-qualified supplemental retirement benefits to certain HCEs as part of the HCE's total compensation. These benefits do not enjoy the tax advantages conferred upon qualified plans. In addition, any assets backing these benefits generally remain company assets and, depending on the funding arrangement, could be withdrawn by the sponsor or made available to creditors in the case of a sponsor bankruptcy. Utilizing flexibilities in the nondiscrimination rules, some plan sponsors have designed ways to indirectly transfer some of these nontax-qualified supplemental executive benefits into their existing tax-qualified DB plans. In effect, plans accomplish this by increasing the benefits under the qualified plan, with an offsetting reduction in the benefits under the nonqualified plan, which extends to the HCE the security of DB plan funding and the tax benefits of a qualified plan. These arrangements, commonly referred to as Qualified Supplemental Executive Retirement Plans (QSERP), can provide HCEs with a higher qualified benefit amount, the tax advantages provided by a qualified plan, as well as the increased benefit security provided by the backing of qualified plan assets. Since QSERPs are provided to HCEs, but are funded by the assets used to pay qualified plan benefits for all employees, some observers have questioned whether these arrangements affect the benefits promised to NHCEs.

(1) The prevalence of Qualified Supplemental Executive Retirement Plans (QSERPs) is unknown because comprehensive data are not available, and we were unable to identify sufficient experts with broad quantitative information on QSERP arrangements. IRS maintains a database that tracks plan sponsors' requests for an IRS determination on the acceptability of pension plan amendments, but it does not capture data to allow for the systematic identification of amendments that have the effect of transferring nontax-qualified benefits into their existing tax-qualified DB plans. We were unable to identify any other private or public data on the prevalence of QSERPs. In addition, there was little qualitative information on their prevalence or design. We found no academic or related literature on the prevalence or design of QSERPs. While many of the pension experts we interviewed were familiar with QSERPs, some stated that they did not possess sufficient specialized knowledge about the prevalence or design of these arrangements. (2) Recent economic conditions, which contributed to a decline in the overall funding of many plans, may have made the implementation of new QSERP arrangements less likely. However, given the lack of data on QSERPs, we cannot confirm whether the number of QSERPs changed in response to the economic downturn. It is possible that plan sponsors could introduce new QSERPs in the future as the ratio of plan assets to plan liabilities improves, but the current pension plan funding requirements of the Pension Protection Act of 2006 (PPA) place limits on the addition of new liabilities to a tax-qualified plan. (3) QSERPs are one of a variety of arrangements that plan sponsors may use to provide additional qualified benefits to HCEs within the constraints of the nondiscrimination rules. (4) Potential QSERP implications may in some instances include a reduced federal income tax liability for plan sponsors and a higher and more secure qualified benefit amount for HCEs. Any effect on the benefit security of NHCEs is uncertain. PPA requirements reduce the likelihood that a QSERP could be added to a plan that did not have sufficient funding to pay promised benefits. It is uncertain what effect, if any, a QSERP arrangement would have on PBGC.