How Tax Changes May Change Your Pension Plans

More highly paid employees may lose pension benefits next year, when the new tax law further limits how much money employers may contribute to qualified retirement plans. Now, the percent of salary an employer kicks in will be based on a maximum of $150,000, down from a $235,000 cap. So if you're making $200,000 and your company was giving 4% a year to your plan, you were getting $8,000. Now, 4% will be taken from $150,000 instead, for a maximum contribution of $6,000. Your company can't increase the percentage for you without raising it for all employees.

If you make more than $150,000, see if your company offers a supplemental executive retirement plan (SERP), which employers adopt to make up for lost pension funds. Labor law limits eligibility to a "select group of management or highly compensated employees," but employers interpret this loosely.

SERPs can hold unlimited funds but lack the security and tax deferral of qualified plans such as 401(k)s. They are simply agreements that the company will pay the extra money when you retire. If the employer ails, fails, or reneges, you can lose.

Several options make SERPs more secure--but all have drawbacks. You can fund a SERP using a "rabbi trust," which protects you against reneging and current taxes but not bankruptcy. A secular trust guards against reneging and bankruptcy but not current taxes. SERPs funded with annuities are the "best combination of tax advantage and security," says Steven Vernon, a Wyatt Co. consultant. An annuity grows tax-free, but you'll pay now on the initial sum. Companies often cover this tax.

Another choice is "split-dollar" life insurance, where you split the premiums with the company. You may have to repay the company's portion when you retire, but you keep any tax-deferred earnings. Beware: The cash value, often stashed in bonds, may yield less than an annuity in mutual funds. For extra protection, buy indemnity insurance, which costs 0.5% tm 1% of the SERP. But you won't get it if insurers "think there's any likelihood they'll have to pay it," says Jim Klein, a Tower & Perrins retirement planning lawyer.

PUT IT IN WRITING. If your employer offers you a SERP, "the first step to security is a well-drafted contract of exactly what the company owes you," says Klein. Companies may agree to pay your legal fees if you must sue for your SERP. "It's another paper promise," says Robert Salwen, a principal at benefits consultant William Mercer, but it reduces the company's incentive to renege.

In the end, SERPs are for employees' benefit, and they usually pay off.

           Bankruptcy      Reneging     Current
      ANNUITY          YES      YES       NO
      RABBI TRUST      NO       YES      YES
      TRUST            YES      YES       NO
      INSURANCE        YES      YES       YES 
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