Following up on our last topic, here’s the question:
How do executive compensation attorneys who regularly negotiate employment contracts for university and college presidents and heads of independent schools achieve a fair compensation package for the holders of those difficult jobs?
In the first place, of course, by pushing back if the base compensation being offered – the annual salary package – seems too low.
Admittedly, there are constraints – some real and some fabricated – on the base salaries of educational leaders which are not applicable to corporate executives. Also, as we noted in the first part of this topic, the salary “bump-up” from dean, provost or even senior vice-president to president can be substantial, obscuring the underlying issue of whether it is adequate given the increased demands of the new job. All of these and other factors need to be considered when looking at the base salary offer.
Once we believe the base salary is adequate, however, our focus, as attorneys negotiating a new or renewed agreement, shifts to other components of compensation. One of the most prominent involves the retirement or post-employment “packages” offered by the school. This is where a knowledgeable and thoughtful negotiation can make a meaningful financial difference for our clients.
Customarily, the educational institution already offers a 403(b) retirement plan for its employees, and often adds a 457(b) plan for a smaller group of its senior administrators. (Both plans are named after the corresponding sections of the Federal tax code.) Moreover, the 403(b) retirement plan often permits the executive, as well as the employer, to make additional contributions; sometimes the school “matches” all or part of the executive employee’s contribution.
The problem with both types of these fundamental retirement plans is that contributions are “capped” at certain amounts specified by IRS regulations.
Accordingly, even with periodic increases to the amounts of these “caps,” they still present a significant limitation to retirement savings for the top executive. One helpful way to put these two types of retirement plans in proper perspective for the president or head executive is that, taken together, they will not add more than $100,000 annually to his or her retirement accounts. This is a modest annual retirement contribution at best, given the all-consuming nature of these top jobs.
This is where another section of the tax code – our good friend Section 457(f) – comes in to bolster – and considerably improve – the retirement savings of chief academic executives (and sometimes a small group of other select executives as well).
A 457(f) plan, sometimes referred to as a SERP, or Single Employee Retirement Plan, if properly crafted, allows the educational (or any) non-profit institution to create a separate retirement plan for the president or head of school which is not limited in terms of the amount of the annual contribution which can be made to the plan.
As an example, if the academic CEO is given an employment contract for a term of five years, that contract could provide that for each year which actually passes, the school will become obligated to put away $200,000 in the 457(f) plan. This means that, at the end of the president’s five-year term, there will be an extra million dollars in the retirement account of the president or head of school in addition to whatever has been put away in the school’s smaller and more limited retirement plan(s).
Of course, since the Federal government is agreeing to defer taxes on these retirement amounts until they “vest” and are paid out at the end of the five-year term, the government insists on certain legal restrictions in connection with any 457(f) or SERP plan.
The most important restriction is that there must be a “substantial risk of forfeiture” of the amounts in the plan, a risk which falls on the executive.
What this means, in practical terms, is that the government does not want our client to have the ability to get his or her hands on the retirement money before the end of the contractual term. Accordingly, if the university or college president or head of school who has an interest in such a 457(f) plan voluntarily resigns before the end of the term (or is fired for “Cause”), they will not receive their SERP retirement money. If, on the other hand, they make it to the end of the contract term, they receive (and must pay taxes on) the entire amount. If the top executive dies, is disabled or is terminated “without Cause” – none of which events is under the executive’s control – they will receive only so much of the account which has accrued under the contract to that point in time.
Generally the academic institution and its Board of Trustees like this type of executive compensation for two reasons: first, and most importantly, a 457(f) plan acts as a powerful incentive – a type of “golden handcuffs” – to keep the president or head from leaving for another position before the end of their contract term (because they thereby would forfeit these significant retirement contributions). Second, the school only has to make a “notation” on the books regarding the money which will be owed as each year of the contract term passes; the school does not have to physically segregate any funds (of course, this might raise other issues for us as executive employment lawyers if there is any real question about the school’s financial strength and its ability ultimately to pay out the funds allocated to the 457(f) retirement account, but that usually is not an issue).
The “bottom line” is that, if the school is only willing to offer a certain level of base salary, the president or head of school’s total compensation can be meaningfully increased by the right kind of retirement planning.
So, finally, to continue the example and solely for the purpose of illustration, if our president receives an adequate base salary, plus housing and other permissible forms of assistance (campus housing, research expense fund, child tuition reimbursement, moving costs, legal fees and possibly other items), plus a retirement fund of between $500,000 – $1.25m after what is likely to be five stressful years, the overall package will be more commensurate with the difficulties of the top job.