The trouble with success is that its rewards are reaped during high-earning years and often don't carry over into later, less productive years.
This is a key problem for all of today's key executives.
They get their major salary increases at the time when they have to pay the largest taxes on them.
How much more advantageous it would be if the increases could be paid out in retirement years, when the tax burden is lower.
Or if the executive died, how much more secure his family would be if they could have the benefit of that salary increase then.
Actually, both these alternatives are available to the present-day executive, through corporate deferred compensation plans.
These are payment devices which, in effect, level out the executive's earnings curve and spread out his compensation during his entire life instead of concentrating it during his working years.
The resultant tax savings increase the amount of spendable cash available to him during his life.
If he dies, his family gets the benefit of both the earnings spread and the tax savings.
Many items in the compensation packages, such as pension and profit-sharing funds, are really forms of deferred compensation.
But because they are qualified, and hence nondiscriminatory (i.
e.
, paid out according to a standard formula to all employees in the group), they are of limited value to the key executive.
The kind of deferred compensation we are discussing now is discriminatory and limited to selected personnel.
It is the result of an individual contract between the corporation and the executive, tailored to the needs of that particular executive.
Suppose our friend Mr.
Key received an offer of a big salary increase from his company, Corporation Americana.
Assume he decided that he wanted this increase deferred.
What precisely does he ask for? The Deferment Contract Deferred compensation agreements generally provide that a salary increase-let us say $10,000-is not to be paid out at the present time but postponed until retirement or termination of employment, when the accumulated sum is paid in installments to the executive, either for the rest of his life or for a certain number of years.
If the executive dies, his family gets the payments he would have received.
Such agreements can be pure deferred compensation, where the employee agrees to defer a portion of his current compensation; or they can be salary continuation plans where the employer provides a cash benefit in addition to the employee's regular compensation.
Often these contracts also provide for the post-retirement consulting services of the executive.
This assures the company that it will continue to have his valuable services, and that he will not go over to a competitor.
This part of the contract should be carefully worked out, however, in order to ensure that the executive will not lose the capital gains treatment, if any, of his package compensation deals (pension, profit sharing, etc.
) because his employment hasn't "terminated.
" The dangers of his being taxed for constructive receipt must also be guarded against.
In actual monies received, how does the executive benefit? If Mr.
Key takes a $10,000 increase immediately he will have only $6,700 left from it after his 33 percent tax.
Under the deferment contract, he may have as much as $7,200 per year left after taxes, if he receives it during the lower-income-tax-bracket years of retirement.
There is a possible thorn in this rosebush called deferred compensation, which a key executive should keep in mind.
Compensation can only be considered "deferred" if it is subject to substantial forfeiture, such as being subject to his loss if the employee leaves prior to a specified age.
During this period of time when the employee has no vesting, the deferred compensation is a general liability of the corporation.
The fund cannot be set up as a trust or set aside for the employee in any way which would remove it from the reach of the corporation's creditors.
In the event of a bankruptcy, even the deferred compensation funds would be available to meet creditors' claims.
This means there is always a possibility that a corporation may not be able to meet the obligations of the deferred compensation contract when the payout is due.
If the company is relatively new, and not proven over time, this may not be a desirable arrangement for Mr.
Key.
With established companies the risk may be small, but it is still there.