Another Schultz-Francis Pension Deception

As regular readers of the Wall Street Journal know, the paper’s conservative editorial page is more than balanced by its left-wing newsroom, and the furthest left corner of that newsroom is occupied by Ellen Schultz and Theo Francis, a duo whose only visible activity is penning screechy op-eds about pension matters under the guise of “news”. Monday brought a typical mixture of ignorance and deception under the title, “Companies Tap Pension Plans To Fund Executive Benefits”. The lead is typical Schultz-Francis bombast:

At a time when scores of companies are freezing pensions for their workers, some are quietly converting their pension plans into resources to finance their executives’ retirement benefits and pay.

In recent years, companies from Intel Corp. to CenturyTel Inc. collectively have moved hundreds of millions of dollars of obligations for executive benefits into rank-and-file pension plans. This lets companies capture tax breaks intended for pensions of regular workers and use them to pay for executives’ supplemental benefits and compensation.

The practice has drawn scant notice. A close examination by The Wall Street Journal shows how it works and reveals that the maneuver, besides being a dubious use of tax law, risks harming regular workers. It can drain assets from pension plans and make them more likely to fail. Now, with the current bear market in stocks weakening many pension plans, this practice could put more in jeopardy.

A layman who reads to the end of the article will never quite learn how the “maneuver” works, so here is an explanation:

Tax-qualified pension plans are forbidden to provide benefits that “discriminate” in favor of “highly compensated employees” (approximately, those who earn over $100,000 a year). The IRS has prescribed rules for evaluating discrimination, which have grown more rigorous and limiting over the years. By these standards, the benefit formulas of most large corporate plans are not merely free of the taint of prohibited discrimination, but affirmatively discriminate in favor of lower paid employees. It is this fact that makes it possible to move “obligations for executive benefits into rank-and-file pension plans”.

Qualified plans are a minor part of the retirement packages of top executives at big firms. At most, a qualified defined benefit pension plan can provide the equivalent of about a $2,000,000 lump sum at age 62 – not peanuts but not what a Fortune 500 CEO counts on for his golden years. Hence, there is, or has been in the past, little incentive to utilize qualified plans fully, and “reverse discrimination” in benefits has been the upshot.

Various developments, particularly changes in accounting rules, have altered that calculus. Liabilities for executive retirement benefits are now less onerous if they are funded, and the only practicable way to fund them is via qualified plans. A secondary factor, which will become more important as tightened funding standards generate pension assets in excess of liabilities, is that surpluses are effectively locked into the plan, recoverable by the employer only at the cost of severe tax penalties. Shifting nonqualified benefits to a company’s qualified plan is one way to utilize part of a surplus.

All that a shift involves is calculating how much higher executives’ benefits would be if they had, all along, been as large as possible without violating the nondiscrimination standards. They are then increased to that extent, and nonqualified benefits are correspondingly cut back. (Executive retirement plans usually provide for an automatic offset for anything received from qualified plans. If they don’t, the shift won’t work.) Sometimes benefits have to be increased for some lower level employees in order to accommodate all of the executive increases that are desired. Schultz-Francis seem to regard that as a bad thing.

They also insinuate that this process takes place in the dark of the night, without any checking to see whether the enhanced benefits actually comply with the nondiscrimination rules:

Companies don’t explicitly tell the IRS that an amendment is intended to shift supplements executive benefits obligations into the regular pension plan. “They hide it,” a Treasury official said. “They include the amendment with other amendments, and don’t make it obvious.”

With too little staffing to check the dozens of pages of actuaries’ calculations, the IRS generally accepts the companies’ assurances that their pension plans pass the discrimination tests, the official said.

Having a lot of experience in this area, I can state bluntly that either Schultz-Francis or their anonymous source is lying. An IRS determination letter covers nondiscrimination issues only if the plan sponsor specifically requests a ruling concerning them, so there is no way to “hide” what is being done. Nor, in my experience, do IRS agents passively accept employer assertions. There may indeed be “dozens of pages of actuaries’ calculations” attached to the submission, but there must also be a clear explanation of how the actuarial methodology fits within the regulations. There are some hyper-aggressive practitioners, but their schemes don’t sail through without resistance. In any event, there is plenty of room in most plans for benefit increases that comply with the most cautious interpretation of the law.

What about the claims that increasing benefits for executives “risks harming regular workers” and “can drain assets from pension plans and make them more likely to fail”? A pension plan can’t “fail”, for practical purposes, unless its sponsor goes into bankruptcy (an eventuality that the reduction in nonqualified benefit liabilities makes modestly less likely). If that happens, then, as the article itself notes, executives’ benefits above a fairly low threshold ($51,750 a year in 2008 for participants who retire at age 65) have last claim on the plan’s assets, behind the “regular workers”, who get exactly the same pensions as if the shift had never taken place.

Shifting liabilities from nonqualified to qualified plans is, on the whole, beneficial to stockholders and thus to employees, whose jobs ultimately depend on their employer’s fortunes. Naturally, we shouldn’t be surprised that Miss Schultz and Mr. Francis, more or less overt socialists, don’t like it.

Comments

[Paul]

Thanks for this explanation. I saw this article and wondered about its accuracy. A few years ago Schultz wrote a number of articles about IBM's defined benefit pension plan conversion to a cash balance plan which caused a lot of consternation amongst employees and retirees. It was almost like she was deliberately providing fodder for their blog tirades.