[Get a Load of CEO Retirement Plans. They are called—I kid you
not—“top hat” plans. And they drain everybody else’s 401(k)s.
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THINK CEO PAY IS OUTRAGEOUS?  
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Timothy Noah
May 18, 2023
The New Republic
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_ Get a Load of CEO Retirement Plans. They are called—I kid you
not—“top hat” plans. And they drain everybody else’s 401(k)s.
_

Walmart chief executive officer Doug McMillon is set to receive
monthly checks of more than $1 million when he retires., Justin
Ford/Getty Images

 

Do you save enough for your retirement? Probably not. You know who
does? Rich people. Not much of a surprise, I know. But you may not
have considered how extravagant retirement planning for top executives
beggars the rest of us. That’s something that never occurred to me
before I read a new report
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retirement inequality from the Institute for Policy Studies, or IPS.

The majority of working-age Americans have neither an employer-funded
defined-contribution plan—typically a 401(k)—nor an
employer-funded defined-benefit plan, known colloquially as “a real,
honest-to-God pension.” Actually, almost no private-sector workers
get real, honest-to-God pensions anymore. Opinions differ on what
killed them, but the decline began in earnest during the 1980s, and
President Ronald Reagan’s policies undermining labor played a large
role
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The invention of the 401(k) played a large role too. In 1978 Congress
added to the IRS Code a section called, yes, 401(k)
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which exempted employees from paying taxes on deferred compensation.
The 401(k) was conceived initially as a tax shelter for the rich,
since it was highly paid employees who were likeliest to receive
deferred compensation (in the form of stock options and bonuses). But
in 1980, Ted Benna, a sharp-eyed benefits consultant working at a
Philadelphia insurance company known today as Johnson, Kendall, and
Johnson, figured out how to democratize
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create tax-protected pensions for ordinary workers, and the IRS
blessed his plan to do so, first at his own company and then
elsewhere.

The problem was that, for businesses offering real, honest-to-God
pensions, the 401(k) proved an irresistibly cheap alternative. That
was because instead of delivering a defined _benefit_ to retirees, the
401(k) delivered with every paycheck a defined _contribution _(a stock
investment subsidized by the company), then left the rest up to the
market. Between 1984 and 2020, the number of workers with defined
benefit pensions fell by more than half, from 30 million
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to 12 million
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During that same period, the proportion of employer-based retirement
money going to defined-benefit pensions dropped from 64 percent
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one-quarter [[link removed]]. Today
it’s more like 14 percent
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and most of those who still have defined-benefit pensions are
government employees, not private-sector workers. Benna ended up
concluding
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he’d created a “monster” that should be “blown up.”

The switch from defined-benefit to defined-contribution was part of
what the Yale political scientist Jacob Hacker has called “the great
risk shift
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wherein conservative domestic policies shifted economic risk from
capital to labor, very much to labor’s disadvantage. That was one
problem. Another was that since maintaining a 401(k) or equivalent
tax-protected retirement plan required employees to set aside part of
their paycheck (which was then matched by the employer), only a little
more than one-third
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of all working-age Americans ended up having a 401(k). Even when they
did, the 401(k) didn’t have much money in it. According to the IPS
study, the median 401(k) account balance at Vanguard, one of the main
investment firms that manages them, is $33,472.

It’s different, of course, for the rich. According to the IPS study,
at the end of 2021, the average retirement balance for an S&P 500
chief executive was $19.4 million. The IRS report is filled with
examples of similarly grotesque inequalities. C. Douglas McMillon, the
chief executive at Walmart, where median _annual _pay is $27,136,
will, when he retires, receive _monthly_ checks of $1,042,300. Ralph
Lauren has $54.4 million socked away in deferred compensation for his
golden years (which have begun already; he’s 83), while fully 41
percent of his employees have zero balances in their 401(k)s, which
means either they never funded them or they had to pull out whatever
they put in (paying a considerable tax penalty in the bargain).

What interests me is causation. Why do so many of Lauren’s employees
have zero balances in their 401(k)s? Because it’s all they can do to
put food on the table; median pay at his company is $26,670. Why is
pay at Lauren’s company so lousy? I can’t speak to that specific
example, but in 2011, Ellen E. Schultz of _The Wall Street Journal_
explained the more general trend
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this way:

Cutting [defined-benefit pensions] … generates paper gains, which
are added to operating income right along with income from selling
hardware or trucks.… Employers’ ability to generate profits by
cutting retiree benefits coincided with the trend of tying executive
pay to performance. Intentionally or not, top officers who
greenlighted massive retiree cuts were indirectly boosting their own
compensation.

Some of that compensation was deferred for retirement. And during this
same period, from the 1980s forward, corporate boards perfected an
ingenious way to shelter from taxation a much larger proportion of
these highest-paid executives’ retirement funds than was available
to their lower-paid employees. This alchemy was achieved through
something called, I kid you not, a top hat plan.

The IRS will let you put only so much cash into a tax-deferred
account, on the theory that if there were no limit, the rich would
take maximum advantage and economic inequality would be even worse
than it is already. (Peter Thiel very obnoxiously figured out a
loophole that allowed him to put $5 billion
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tax-free into a Roth IRA, but let’s set that aside.) The annual
contribution limit on a 401(k) is $22,500, or $30,000 if you’re over
age 50. That’s the limit on how much of your income the IRS is
willing to let you shelter in any given year for retirement.

But a top hat plan, unlike a 401(k) or any other government-sanctioned
pension, has _no limit_ on how much money you can accrue on a
tax-deferred basis. That’s because, through a variety of accounting
tricks, corporate America figured out how to shelter unlimited funds
for retirement.

It began, as so many things do, with a bungled attempt by the federal
government to do good. In 1974 Congress passed the Employee Retirement
Income Security Act, or ERISA, which regulates pensions in various
ways. Businesses wanted to exempt from ERISA’s protections a certain
type of retirement scheme wherein the funds would not be walled off
from potential creditors in the event of bankruptcy, or be protected
from some other unforeseen calamity. ERISA-covered pension funds are
shielded from such dangers. Fine, Congress said, accept the risk, but
you must limit participation in this unprotected arrangement to your
very wealthiest employees, because only they can survive outside
ERISA’s bosom. In practice, this group is typically the highest-paid
5 to 15 percent of the workforce.

The exemption created a problem. Sure, this deferred compensation
wasn’t hemmed in by ERISA, but since these unprotected funds
weren’t legally recognized as a pension, contributions to this
retirement fund would be taxed just like any other income. Corporate
America’s greatest minds set to work on this difficulty and came up
with the top hat fund.

Here’s how it worked. Instead of creating a retirement account for a
Mr. Top Executive, the company created a contract. In the contract,
the company pledged to make a large quantity of money available to Mr.
Top Executive in retirement. The precise amount would be based on the
assumption that if we invested _x _amount of agreed-upon capital with
a return rate of _y _(also negotiated; often it’s based on the rate
at which the company 401(k) expands), then by a certain future date, a
larger amount _z_ would be available on terms resembling those of a
pension. This is, as you can imagine, an enormous financial commitment
for the company, and whatever cash eventually went out the door to Mr.
Top Executive wouldn’t be available to pay employees struggling to
set aside contributions to their 401(k)s.

Why doesn’t the IRS tax this money? Because there is no _actual
_capital, there is no _actual _return rate, and there is no _actual_
retirement fund. There’s only a piece of paper promising to pay Mr.
Top Executive _as if _he had a retirement fund in some alternative
universe. Mr. Top Executive maintains no property right to this
promised payout because it doesn’t exist until he receives it. It
doesn’t vest, it isn’t held in trust, and if new management comes
in and says hell no, we aren’t paying this outrageous sum, Mr. Top
Executive will have to take them to court.

“Congress never explicitly decided to give top hat plans favorable
tax treatment,” Mark Iwry, a nonresident senior fellow at the
Brookings Institution, explained to me. “But by largely prohibiting
Treasury and IRS from regulating their taxation, it allowed the
system, based on general tax principles, to evolve to its current
state.”

Mr. Top Executive will of course have to pay taxes on whatever money
he eventually draws from his top hat fund, just as you and I will have
to pay taxes on whatever money we draw from our 401(k). The difference
is that the quantity Mr. Top Executive will have to draw on will be
much greater, and that’s partly because he will have sheltered a
much larger portion of his earnings from taxation. Yes, Mr. Top
Executive didn’t get the same regulatory protection you and I got in
our 401(k)s. But he’s so much richer to begin with that he can
afford to take some risks. And anyway, according to a 2020 Government
Accountability Office report
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companies go bust, their Mr. Top Executives are often able to extract
their top hat funds before the company files for bankruptcy. Or if Mr.
Top Executive stays on after the reorganization, the GAO said, he’ll
have a decent shot at keeping most or all of his top hat fund. That
great risk shift? It’s not for people like Mr. Top Executive.

Top hat retirement funds are proliferating like mad. According to the
IPS report, in 2022 one financial firm saw a 33 percent increase in
the number of its clients offering top hat funds. Another financial
firm said it advised more clients on top hat funds during the past 12
to 18 months than during the previous six years. Some of these
deferred-compensation arrangements may not fit the precise parameters
I describe here but are more in the way of variations. (I’m
intrigued by one variation that’s called a “rabbi trust
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when a synagogue wanted to shelter its rabbi’s pension.
_L’chaim_!) Perhaps collectively I should refer to these variations
(with apologies to Irving Berlin and Fred Astaire
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and tails funds.

Whatever you call them, they’re an outrage. There are technical ways
Congress can limit their growth. One was considered
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Republican-controlled Ways and Means Committee in 2017 but didn’t
advance. Another was introduced
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by Senator Bernie Sanders, independent of Vermont, in 2020; it
didn’t advance either. A difficulty is that corporate promises to
pay out make top hat funds hard to distinguish legally from more
legitimate deferred-compensation arrangements like merit bonuses or
royalties or payment on completion of a construction project. Probably
we’d be better off taxing more of the income Mr. Top Executive
finally withdraws from his top hat or white tie or tails fund and
increasing taxes on other sources of plutocratic wealth like capital
gains.

In the meantime, the rich will continue to impoverish the rest of us
with the blessing of the IRS. The earthy twentieth-century novelist
Henry Miller (_Tropic of Cancer
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etc.) had printed at the bottom of his personal stationery what he
claimed to be a Portuguese proverb, though its provenance is hard to
pin down: _Cuando merda tiver valor pobre nasce sem cu._ That
translates: “When shit becomes valuable, the poor will be born
without assholes.” The top hat pension is merely the latest example.


Timothy Noah [[link removed]]

Timothy Noah is a _New Republic_ staff writer and author of _The Great
Divergence: America’s Growing Inequality Crisis and What We Can Do
About It_.

 

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