Pitfalls In Continuing Pensions And Benefit Plans
Submitted by Elliot D. Raff, Flaster/Greenberg P.C.
Pension and other employee benefit plans present many pitfalls that may be ruinous. Following is my short summary of some of the greatest dangers on acquiring a company:
1. Underfunded Defined Benefit Plans. “Defined benefit” plans are traditional qualified retirement plans that provide an annuity at retirement based on such factors as average compensation, years of service, and age. The chief financial risk related to such plans arises because the employer-sponsor must satisfy minimum funding requirements (determined annually by an independent actuary), which do not necessarily produce an immediate equivalence between existing plan assets and current benefit obligations. Funding is interest-rate sensitive (low rates inflate liabilities), demographic sensitive (current liabilities increase as employees age) and, obviously, asset-value sensitive (lower than assumed asset value). Plan termination is subject to government review and approval, and comply with certain financial thresholds. Thus, an underfunded defined benefit plan can quickly become extremely expensive to maintain and impossible to terminate.
2. Multiemployer Pension Plans. Often, the defined benefit plan is a multiemployer pension plan sponsored by a labor union for a group of employers. For example, United Food and Commercial Workers Union (“UFCW”) locals sponsor pension plans for all employers under contract with the UFCW. These plans are almost universally underfunded. Although contribution rates may be affordable on a cash-flow basis, exiting such a plan will nearly always give rise to “withdrawal liability” -- colloquially described as “the employer’s fair share of the underfunding.” Withdrawal liability attaches to all entities under common control with the sponsor and so acquiring a company with withdrawal liability would expose the buyer and subsidiaries to this liability. Further, if not carefully structured, the sale of a business may create withdrawal liability even where the seller’s employees become employees of the buyer, and the buyer joins in the plan.
3. Leveraged ESOPs. A leveraged employee stock ownership plan (“ESOP”) is a special type of qualified retirement plan that borrows funds in order to purchase stock of the sponsoring corporation. Typically, a leveraged ESOP will hold at least 30 percent of the stock issued by the sponsor and will have corporate executives as Trustees. A stock transaction presents numerous complex tax compliance issues, particularly if the buyer wants to “de-leverage” and terminate the ESOP. In addition, Trustees may have to decide whether to approve a transaction on behalf of the ESOP, a decision that is subject to ERISA’s fiduciary obligations.
4. Non-Qualified Deferred Compensation. The 2004 Tax Act created strict statutory requirements that must be satisfied in order for non-qualified deferred compensation plans (such as stock appreciation rights plans, executive deferred compensation plans, or supplemental executive retirement plans) to effectively defer income taxation and minimize Social Security taxation. Under IRS guidance, certain stock options and related equity arrangements will be treated as non-qualified deferred compensation plans, which must comply with the new law (and which would effectively destroy the intended option treatment). At the present, such plans are in a transition period, during which certain “old law” rules continue, but all NQDC plans must be brought into formal compliance with the new law and IRS regulations by December 31, 2007. Failure to comply may result in tax costs and penalties imposed on executives whose security may be the key to a successful post-transaction integration and growth.
5. Retiree Health Insurance. Although not legally required, many employers have promised employees that they would be providing retirees with lifetime health insurance. This is typically an extremely expensive benefit and its cost is impossible to project and difficult to eliminate.
6. COBRA. Depending on the structure of the acquisition transaction, the sale of a business may trigger COBRA obligations. Typically, the obligation will be the seller’s obligation However, in some cases, such as the seller ceases all operations and no longer offers any health insurance, the buyer may have COBRA obligations to seller’s former employees and create legal obligations to provide COBRA notice, etc.
7. Disqualification of Qualified Plans. Qualified retirement plans (such as pension plans and 401(k) plans), must meet a host of annual non-discrimination tests. Failing any of these tests disqualifies the plan, which can have potentially ruinous financial consequences — e.g., a tax penalty based on taxes triggered by a disallowance of contribution deductions, personal income taxation of contributions allocated to highly compensated employees, personal income taxation of rollovers, and taxation of trust earnings. If the buyer merges the seller’s disqualified plan into its pre-existing qualified plan, it would taint the buyer’s plan’s qualification as well. While virtually all qualification failures can be corrected through voluntary correction procedures, this requires discovering the failure and bringing it to the IRS’s attention before the IRS discovers the problem on its own.
All of these issues can be discovered through proper due diligence and then either protectiveprovisions can be negotiated or corrective action taken in advance of constructed commitment or closing.
Planning Your Finances During All Stages of Life
Submitted by Newell W. Anderson Jr., RBC Dain Rauscher
Building a financial plan tailored to your current situation is essential, but as many financial professionals will tell you, it’s equally important to factor in the future. As you grow older, you will likely have different concerns regarding your finances, which is why it is important to address each stage of life differently.
Your 20s: Time is of the Essence
When you’re in your 20s, the biggest asset you have is usually time, not money. Many people in their 20s have gained the education or skills they need to start a job, and are beginning to learn how to manage and invest their money. With the “time” factor in mind, it’s important to start investing that hard-earned money as soon as possible. If you start investing your money regularly at a young age, whether it’s through a 401(k) or IRA, you can build a large nest egg with relatively little effort.
Your 20s are also a great time to start identifying your short- and long-term goals. Think about what you want to achieve financially, and learn how you can budget to make it happen. If you have credit card debt, it’s important to consider that in your budget planning. Try to get that debt behind you. Even if you can’t pay off your credit card, try to pay more than the minimum amount due each month. If you pay only the minimum balance, chances are it’s barely enough to cover the card’s interest expenses.
Your 30s and 40s: Staying on Track
While your 20s are about building financial goals, your 30s and 40s should be about staying on track with those goals. If you have a 401(k), make sure you are investing as much as you can, or at least enough to get meet your employer’s matching contribution. If you’re planning to change jobs, don’t make the mistake of cashing out your plan. Instead, leave the money in your old employer’s plan or transfer it to your new employer. If you do not have those options, consider rolling your assets into an IRA. This will allow your savings to continue to grow, and it also provides the opportunity to consolidate your retirement savings in one place.
If you have children, start planning for their future. The earlier you start, the better. Consider custodial accounts, Section 529 Plans or Coverdell Education IRAs. Adequate life insurance should also be a priority if you have a family. But whether you’re a parent or not, it’s still a good idea to make sure your insurance coverage keeps up with your changing circumstances.
Your 50s and 60s: Focus on Retirement
In your 50s and 60s, you are likely at the highest income level of your career. As you near retirement, it’s important to figure out whether or not you’ll be able to maintain that standard of living after you retire. Take stock of where you are and determine if you should increase your retirement contributions. Work with your financial consultant to estimate what your expenses will be during retirement.
It’s also a good time to evaluate asset allocations to make sure they’re still in line with your goals and comfort level. You might have been able to afford more risk when you were younger, but as you get closer to retirement, you may want to consider more conservative investments.
Additionally, you should review your will to make sure you’ve chosen a power of attorney who can make financial decisions on your behalf. You should also have a living will that outlines your wishes if you become seriously ill or injured. If you haven’t established these documents at this stage in your life, consult a qualified estate attorney.
Wise preparation can mean a comfortable retirement, but don’t think that financial planning is over once you reach your golden years. It’s still important to manage your investments carefully, and make sure your insurance protection keeps up with your needs. You should also consider the legacy you would like to leave behind for your family or community. After all, you’ve worked hard to make your money last this long. Imagine how much further it can go.
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