What You Might Find in the Actuary's Bag of Tricks

As actuaries, we work a lot with attorneys. In fact, for the most part, those attorneys are what as known as ERISA attorneys, employee benefits attorneys, executive compensation attorneys, and tax attorneys. Save perhaps intellectual property attorneys/patent attorneys, the ones that we work with would be considered the geekiest by their peers. Some have quite a bit of quantitative ability. Some have actuarial training. A few are credentialed actuaries. For the most part, however, even actuaries who happen to be practicing law don't think the same way that experienced, practicing actuaries do. For their clients, that's probably a good thing as they are engaged to think as lawyers. Similarly, those practicing actuaries who happen to be attorneys as well tend to think as actuaries. And, since that is why they are engaged by their clients, that's probably a good thing as well.

Okay, John, you've written a paragraph saying that actuaries and attorneys are different people. We all know that. Who cares?

Let me illustrate with a case study where the names and numbers have been changed to protect the innocent. And, while those elements are changed, this really happened.

Two similar Fortune 1000 companies were getting ready to merge. Technically, company Y was buying Company Z (they were keeping Z's name, but keeping Y's management team, Z's shareholders would receive stock in Y, and Z's executive team would generally be the beneficiaries of golden parachutes).

The deal was to close on a Friday morning. One of my colleagues was spearheading the benefits and compensation side of due diligence. He was very good at his job, but he was not an actuary. We'll call him Eddie just so that he can have a name.

Late that Wednesday afternoon, I was contacted by Eddie. He told me about the deal he was working with and that he had run into a strange looking SERP. I'll spare you the details, but when he described it to me, it was like none I had ever encountered. He asked if I had some time to look at it which I did.

What had happened was that the old CEO of Z had had a custom-designed SERP and employment agreement and then he went and upset the apple cart -- he died completely unexpectedly. The Board knew who had been intended as the CEO's heir apparent although that was not supposed to happen for a little more than five years. With nowhere else to turn, YRS (young rising star) became the CEO. Frankly, YRS was probably a pretty good choice, but when things are done in a hurry, things can go wrong.

The SERP and employment agreement that the old CEO had had been written by counsel. Counsel said that an actuary had valued the SERP and that the company was comfortable with the costs. So, right along with the rest of the employment agreement, the YRS, the new CEO, got the same package.

The SERP itself wasn't too unusual as it turned out. But, when you integrated the SERP with the employment agreement which was necessary in the event of a change in control, the numbers just exploded.

After determining that the golden parachute payout of the SERP alone was to exceed the entire balance sheet of the merged company (that part is true without specifying numbers), talking to the Chairman of the Board of Y, and working on negotiations with YRS, I did spend some time with Y's management and counsel. I asked them as nicely as I could how they could have given YRS this package without really understanding it. I was informed that an actuary had carefully analyzed the SERP when it was written for the old CEO and he had said there was nothing wrong with it. Therefore, there should not have been a problem giving the same SERP to YRS.

But, the actuary had never seen the employment agreement. And, he had never done his analysis in the context of the employment agreement, a young CEO, and a change in control.

The attorneys in this particular case were good at their jobs. I've worked with them since and seen that. In fact, they are fairly facile quantitatively. But, they think as attorneys (as they should). They don't think as actuaries. And, that was the problem.

So, when you run into a complex quantitative situation where there might be some contingencies involved, save yourself some significant risk and find an actuary who can help.

Ultra-High Earners, How Much Can You Really Defer?

A lot of what we might describe as ultra-high earners (say $500,000 US per year or more) would love to have more tax-favored savings. Physicians, attorneys, and others who are owners of their businesses struggle with this.

In a fairly common design scenario, here is what they can defer into a qualified retirement plan (tax-favored, secure from creditors):

• $16,500 ($22,000 if they reach age 50 or older during the year) to a 401(k) plan
• $22,050 in a profit sharing plan. This is 9% of $245,000 (pay cap). We use 9% because by contributing 3% of pay on behalf of nonhighly compensated employees (NHCEs), the owners are usually able to contribute 9% (3 times 3) to their own accounts
• Perhaps a matching contribution (not more than about $11,000) in the 401(k) plan, but only if they make similar percentage of deferral matches for NHCEs, and the NHCEs participate in the plan to a great enough extent.

Suppose someone told you that by putting aside a little bit more for your NHCEs (generally tax deductible, but you should seek appropriate legal or tax counsel before proceeding), you could quintuple your own deferrals if you are at least age 62 (the numbers are smaller for younger ages, but can triple as early as your 40s). Go through the math, or trust me. Because of the tax deductibility of all these contributions (if you can afford to make them), your income plus deferrals less taxes will often increase ... and you get the benefit of tax-deferred buildup, secure from creditors.

The mechanics aren't that simple, but that's why there are experts. From your standpoint, you just need the willingness to do this, good advisors, and proper counsel.