US: Companies Tap Pension Plans To Fund Executive Benefits

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.

How many is impossible to tell. Neither the Internal
Revenue Service nor other agencies track this maneuver. Employers
generally reveal little about it. Some benefits consultants have warned
them not to, in order to forestall a backlash by regulators and
lower-level workers.

The background: Federal law encourages employers to
offer pensions by giving companies a tax deduction when they contribute
cash to a pension plan, and by letting the money in the plan grow tax
free. Executives, like anyone else, can participate in these plans.

But their
benefits can't be disproportionately large. IRS rules say pension plans
must not "discriminate in favor of highly compensated employees." If a
company wants to give its executives larger pensions -- as most do --
it must provide "supplemental" executive pensions, which don't carry
any tax advantages.

The trick is to find a way to move some of the
obligations for supplemental pensions into the plan that qualifies for
tax breaks. Benefits consultants market sophisticated techniques to
help companies do just that, without running afoul of IRS rules against
favoring the highly paid.

Intel's case shows how lucrative such a move can be.
It involves Intel's obligation to pay deferred compensation to
executives when they retire or leave. In 2005, the chip maker moved
more than $200 million of its deferred-comp IOUs into its pension plan.
Then it contributed at least $187 million of cash to the plan.

Now, when the executives get ready to collect their
deferred salaries, Intel won't have to pay them out of cash; the
pension plan will pay them.

Normally, companies can deduct the cost of deferred
comp only when they actually pay it, often many years after the
obligation is incurred. But Intel's contribution to the pension plan
was deductible immediately. Its tax saving: $65 million in the first
year. In other words, taxpayers helped finance Intel's executive
compensation.

Meanwhile, the move is enabling Intel to book as much
as an extra $136 million of profit over the 10 years that began in
2005. That reflects the investment return Intel assumes on the $187
million.

Fred Thiele, Intel's global retirement manager, said
the benefit was probably somewhat lower, because if Intel hadn't
contributed this $187 million to the pension plan, it would have
invested the cash or used it in some other productive way.

The company said the move aided shareholders and
didn't hurt lower-paid employees because most don't benefit from
Intel's pension plan. Instead, they receive their retirement benefits
mainly from a profit-sharing plan, with the pension plan serving as a
backup in case profit-sharing falls short.

The result, though, is that a majority of the
tax-advantaged assets in Intel's pension plan are dedicated not to
providing pensions for the rank and file but to paying deferred
compensation of the company's most highly paid employees, roughly 4% of
the work force.

On the Hook

And taxpayers are on the hook in other ways. When
deferred executive salaries and bonuses are part of a pension plan,
they can be rolled over into an Individual Retirement Account --
another tax-advantaged vehicle.

Intel believes that its practices "feel consistent"
with both the spirit and letter of the law that gives tax benefits for
providing pensions.

Intel may be a model for what's to come. Many
companies are phasing out their pension plans, typically by "freezing"
them, i.e., ending workers' buildup of new benefits. This leaves more
pension assets available to cover executives' compensation and
supplemental benefits. A number of companies have shifted executive
benefits into frozen pension plans.

Technically, a company makes this move by increasing
an executive's benefit in the regular pension plan by X dollars and
canceling X dollars of the executive's deferred comp or supplemental
pension.

CenturyTel, for instance, in 2005 moved its IOU for
the supplemental pensions of 18 top employees into its regular pension
plan. Chief Executive Glen Post's benefits in the regular pension plan
jumped to $110,000 a year from $12,000. A spokesman for the Monroe,
La., company, which made more such transfers in 2006, was frank about
its motive: to take advantage of tax breaks by paying executive
benefits out of a tax-advantaged pension plan.

How They Do It

So how can companies boost regular pension benefits
for select executives while still passing the IRS's nondiscrimination
tests? Benefits consultants help them figure out how.

To prove they don't discriminate, companies are
supposed to compare what low-paid and high-paid employees receive from
the pension plan. They don't have to compare actual individuals; they
can compare ratios of the benefits received by groups of highly paid
vs. groups of lower-paid employees.

Such a measure creates the potential for
gerrymandering -- carefully moving employees about, in various
theoretical groupings, to achieve a desired outcome.

Another technique: Count Social Security as part of
the pension. This effectively raises low-paid employees' overall
retirement benefits by a greater percentage than it raises those of the
highly paid -- enabling companies to then increase the pensions of
higher-paid people.

Indeed, "it is actually these discrimination tests
that give rise to Qserp in the first place!" said materials from one
consulting firm, Watson Wyatt Worldwide. "Qserp" means
"qualified supplemental executive retirement plan" -- an industry term
for a supplemental executive pension that "qualifies" for tax breaks.

Watson Wyatt senior consultant Alan Glickstein said
the firm's calculations tell employers exactly how much disparity they
can achieve between the pensions of highly paid people and others. "At
the end, when the game is over, when the computer is cooling off, you
know whether you passed [the IRS nondiscrimination tests] or not," he
said. At that point, companies can retrofit the benefits of select
executives, feeding some into the pension plan.

They can do this even if they freeze the pension plan,
because executives' supplemental benefits and deferred comp aren't
based on the frozen pension formula.

Keeping Quiet

Generally, only the executives are aware this is being
done. Benefits consultants have advised companies to keep quiet to
avoid an employee backlash. In material prepared for employers, Robert
Schmidt, a consulting actuary with Milliman Inc., said that to
"minimize this problem" of employee relations, companies should draw up
a memo describing the transfer of supplemental executive benefits to
the pension plan and give it "only to employees who are eligible."

The IRS was also a concern for Mr. Schmidt. He advised
employers that in "dealing with the IRS," they should ask it for an
approval letter, because if the agency later cracks down, its
restrictions probably won't be retroactive.

"At some point in the future, the IRS may well take
the position" that supplemental executive pensions moved into a regular
pension plan "violate the 'spirit' of the nondiscrimination rules," Mr.
Schmidt wrote. In an interview, he confirmed his written comments.

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.

"Under existing rules, there's little we can do
anyway. If Congress doesn't like it, it can change the rules." To halt
the practice, Congress would have to end the flexibility that companies
now have in meeting the IRS nondiscrimination tests.

A spokesman for the IRS said it has no idea how many such pension amendments it has approved or how much money is involved.

A Way to Pass

Sometimes, the only tipoff that a firm is moving
executive benefits into the regular pension is that it provides small
increases to some lower-paid groups in the plan, in order to pass the
nondiscrimination tests.

Royal & SunAlliance, an insurer, sold a division
and laid off its 228 employees in 1999. Just before doing so, it
amended the division's pension plan to award larger benefits to eight
departing officers and directors. One human-resources executive got an
additional $5,270 a month for life.

But to do this and still pass the IRS's
nondiscrimination tests, the company needed to give tiny pension
increases to 100 lower-level workers, said the company's benefits
consultant, PricewaterhouseCoopers. One got an increase of $1.92 a
month.

Joseph Gromala, a middle manager who stood to get
$8.87 more a month at age 65, wrote to the company seeking details
about higher sums other people were receiving. A lawyer wrote back
saying the company didn't have to show him the relevant pension-plan
amendment.

Mr. Gromala then sued in federal court, claiming that
administrators of the pension plan were breaching their duty to operate
it in participants' best interests. The company replied that its move
was a business decision, not a pension decision, so the fiduciary issue
was moot. The Sixth U.S. Circuit Court of Appeals agreed.

PricewaterhouseCoopers declined to comment. A
spokesman for Royal & SunAlliance's former U.S. operation, now
called Arrowpoint Capital, said the pension plan "wasn't
discriminatory." Royal & SunAlliance recently changed its name to RSA Insurance Group.

Pension-plan amendments like the documents Mr. Gromala
sought must be filed with the IRS, but the agency normally won't
disclose specifics such as who benefits. The IRS says it can't release
details of the amendments because they reflect individuals' benefits.

Not So Safe

Employers sometimes tell executives that moving their
supplemental pensions or deferred comp into the company pension plan
will make them more secure. Normally, supplemental pensions or deferred
comp are just unsecured promises; companies don't set aside cash for
supplemental executive pensions and deferred comp because there's no
tax break for doing so. But the promises will be backed by assets if
the company can squeeze them into a tax-advantaged pension plan.

This supposed security can prove illusory, as executives at Consolidated Freightways found out.

The trucking firm moved most of its retirement IOUs
for eight top officers into its pension plan in late 2001. It said this
would protect most or all of their promised benefits, which ranged up
to $139,000 a year.

This came as relief to Tom Paulsen, then chief
operating officer, who says he knew the Vancouver, Wash., trucking
company was on "thin ice."

But the pension plan was underfunded. And Consolidated
didn't add more assets to it when the company gave the plan new
obligations. Adding the executive IOUs thus made the plan weaker. It
went from having about 96% of the assets needed to pay promised
benefits to having just 79%.

Losing Benefits

Consolidated later filed for bankruptcy and handed its
pension plan over to a government insurer, the Pension Benefit Guaranty
Corp. The PBGC commits to paying pensions only up to certain limits.
Mr. Paulsen said he and other executives have been told they won't get
their supplemental pensions.

Some lower-level people will lose benefits, too.
Chester Madison, a middle manager who retired in 2002 after 33 years,
saw his pension fall to $20,400 a year from $49,200. Mr. Madison, 62,
has taken a job selling flooring in Sacramento, Calif.

He faults those who made the pension decisions. "I look at it as greed and taking care of the top echelons," he says.

It's impossible to know how much the addition of
executive pensions to the pension plan contributed to the plan's
failure. But in this as in similar companies where a plan saddled with
executive benefits failed -- such as at kitchenware maker Oneida Ltd.
in upstate New York -- it's clear the move weakened the plans by adding
liabilities but no assets.

A trustee for Consolidated's bankruptcy liquidation declined to discuss details of the company's pension plan.

Mr. Madison and five other ex-employees sued Towers
Perrin, a consulting firm that had advised Consolidated on structuring
its benefits. The suit, alleging professional negligence over this and
other issues, was dismissed in late 2006 by a federal court in the
Northern District of California. Towers Perrin declined to comment.

Some companies, after moving executives' supplemental benefits into a pension plan, now take steps to protect them. When Hartmarx
Corp. added executive obligations to its pension plan last year, it set
up a trust that automatically would be funded if the plan failed.

Glenn Morgan, the clothier's chief financial officer,
said the trust benefits nine or 10 people. "The purpose is to pay them
the benefit they've earned," he said.

Write to Ellen E. Schultz at ellen.schultz@wsj.com⁶ and Theo Francis at theo.francis@wsj.com⁷

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