Retirement Plan Consultant
Cetera Retirement Plan Specialists
Blue Ridge ESOP Associates
(Charlottesville VA / Telecommute)
“BenefitsLink continues to be the most valuable resource we have at the firm.”
-- An attorney subscriber
First, what is a Book Reserve Plan? In easy terms, it is a retirement arrangement that is funded through allocations on a company's balance sheet. It is not a "pay-as-you-go" plan which is a retirement arrangement that is not funded.
It is also not externally funded. The sponsoring company maintains control of the assets behind the liabilities.
Although not a required feature of Book Reserve plans, the assets are usually not segregated; the typical book reserve plan can not look at a particular group of assets as being "owned" by the plan. However, the plan sponsor could, if permitted by corporate powers, set up a segregated pool of assets. But, as with the ideal situation with all Defined Benefit plans, surplus assets (assets greater than the current liabilities to the employees) belong to the sponsor.
In Japan, the plan sponsor gets a tax deduction for accruals to his book reserve liability. Since these deductions represent deductions for amounts not actually spent they do represent substantial value to the sponsor.
The point is, regardless of turnover, anything less than 100% turnover results in deductions in advance of payments to former employees. Figure 1 illustrates that, in a high turnover environment, there are many years (the "x" axis) of improved cash flow (the negative of the "Y" axis, representing outgo). The darker line is calculated on a "pay-as-you-go" basis.
When turnover is lowered to the point that employees only leave for age-retirement or death, as in figure 2, a taxable firm will see positive cash-flows (below zero on the graph) for many years. As you may see in Figure 2, a sponsor with low turnover is particularly well-rewarded.
The positive cash flows are the result of deducting benefits paid to departing employees many years before the actual payments are due.
So, what sort of conditions are needed to make a Book Reserve plan a positive contributor to organizational goals?
The above two graphs emphasize two important characteristics; you should have low turnover and be ultimately taxable. This will result in positive cash flows. The financial advantage comes from the interest-free loan and the resulting arbitrage when the money is invested in the company itself. While there is always a financial advantage to the Book Reserve system, it diminishes as turnover increases and as the marginal tax rate reduces.
We say ultimately taxable, because some companies that should be using or are using the Book Reserve system are not currently taxable. While it might be nice to establish a TQPP while turnover is high and marginal tax rates are low, then move the funding in-house as conditions improve, the typical external vehicle in Japan does not permit an easy change from external funding to internal, meaning you must plan based on the future.
There are other considerations in the internal vs. external funding argument, but they are not financial. In addition to the opportunity cost, there is a positive real cost to using an external vehicle. The sponsor must put a dollar value on the non-financial aspects, then see if the move to external funding would exceed it.
You have been reading the online edition of LIA $FACTS$, the monthly fax newsletter of Lohmann International Associates. For further information, please visit our home page on the Web or send e-mail to Les Lohmann.