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International employees: are they losing out on retirement?

International employees: are they losing out on retirement? The maturing of the world economy has created a new breed of executive--the globe-trotter, the product of multinational companies reaching into those now lucrative business climes of Europe and Asia.

Of course, today's new breed does have predecessors. After World War II, for example, many American companies ventured overseas; often, they sent expatriates to spearhead the effort. In those days, the life of the "expat"--what with foreign service premiums, hardship allowances, extended home leave, tax equalization, and education allowances, coupled with the fact that goods and services purchased with American dollars were often incredibly cheap overseas--was very cushy compared to that of his counterpart back home.

But the days of extreme coddling are coming to an end, and that's what distinguishes the new breed of globe-trotter. Going international is no longer a frill activity that provides incredible opportunities to those with the guts and energy to uproot their families. It's now a necessary part of any multinational's business strategy. And not only do companies have to do it; they have to do it in a cost-conscious way. Thus, compensation and benefit programs have to be specifically designed to meet the needs of the new breed.

In particular, providing retirement benefits to international employees has always been difficult. "Risk" benefits--medical, disability, and life--pose problems of their own, but at least the time horizon is limited, usually a one-year-at-a-time proposition. But retirement plans operate over much longer time spans.

Retirement income is a basic need of employees, and provision for it on a group basis by employers is a fairly universal phenomenon among developed countries. However, the form retirement plans take in a given country is largely a function of tax incentives and the provisos attached to them, the Social Security systems they supplement, and business customs. Incredible diversity among regions, and among countries within each region, is the result. That diversity complicates the job of providing a sensible benefit to an international employee.

Within the European Community, very little progress has been made toward enabling companies to establish plans that transcend borders. While coordination of Social Security benefits for workers crossing those borders is well established, the rules governing private plans continue to exhibit a stubborn individualism. Unfortunately, the scope of Europe 1992 doesn't really include this issue.

The world of international pensions can indeed be intimidating to the non-expert. American businessmen are conscious of the complexity of U.S. pension legislation, especially since ERISA was enacted some 15 years ago. The fact is that most countries of note in the "free world" (how long will that phrase be meaningful?) have seen their own versions of ERISA. Keeping track of all the details can be mind-boggling.

It's a messy situation. However, as usual, much of the messiness is just detail work that can be delegated to the expert. What management needs to know are the answers to more basic questions: Just who are these international employees? What are the problems of providing benefits to globe-trotters that are unique to that group? What general approaches are available to deal with those unique problems?

Who are the globe-trotters?

International employees can be broken down into three distinct groups: expatriates (expats), third-country nationals (TCNs), and key local nationals (KLNs). Those are the commonly used labels, but they are actually misleading. We prefer the more descriptive, if slightly frivolous, labels of "emissaries," "nomads," and "chieftains." Each group poses a slightly different pension dilemma that cannot be solved by normal means, but there are two common threads: tax complications and design problems.

The emissaries

Emissaries are those employees who are standard and local (albeit generally highly paid and "fast track") and who, at some point in their careers, find themselves on temporary overseas assignment. From the start, there is the understanding that these employees will go back to being standard, local employees; the overseas assignments are temporary interludes in their careers.

Emissaries are typically citizens of the parent company's country assigned to work temporarily in a foreign subsidiary, but their nationality isn't really relevant. Nor is it important that they be emissaries from the parent company. They might be emissaries from a prominent subsidiary to the parent company or occasionally even emissaries from one subsidiary to another. What defines them is the temporary nature of their assignment.

Because these assignments are temporary interludes, the normal impulse is to keep emissaries in their home-country plans. While that is a satisfactory design solution, it does lead to vexing tax problems. For example, the IRS generally doesn't consider employees assigned to work for a subsidiary employees of the parent, or vice-versa. The subsidiary and the parent are considered separate, distinct companies. Consequently, compensation or benefit costs may not be deductible if paid by a company for which the employee doesn't directly work.

Another tax problem: the parent-company's plan is tax qualified in its own country, but not in the country to which the employee is assigned. One main advantage of tax qualification is that current taxability to the employee is avoided (for example, under a funded retirement plan in which the employee is vested). That advantage may not be available if the participant becomes a taxpayer in a foreign jurisdiction.

Emissaries are sometimes treated differently depending on whether the assignment is short term or long term. For short-term assignments, the tendency is to keep the employee in the home-country plan. For long-term assignments, participation in the host-country plan (perhaps more often for risk benefits than for pensions) is more common. The dividing line between short and long term is usually three to five years.

The nomads

Nomads are the purest form of international employees, those whose whole careers consist of temporary assignments in overseas locales, with perhaps a stint or two at their home offices. Some companies have entire cadres of such employees. Often, those employees are true TCNs--citizens of Country X, working in Country Y for a multinational based in Country Z. As with emissaries, however, nationality is not the relevant point. What distinguishes nomads is mobility; they spend no more than five to ten years in any one location.

Nomads do not lend themselves to the home-country approach. The multinational employer may not even have a subsidiary in their home countries. Also, because such employees are so mobile during their working careers, they are not particularly likely to settle down at retirement in, say, the country of their citizenship, or anywhere else that can be predicted in advance. So the logic of home-country coverage breaks down. Some multinationals provide parent-company coverage to nomads. For the most part, however, nomads tend to be included in host-country plans, more so than emissaries, at any rate.

Nomads are subject to the same tax complications as expats. Sometimes their problems are even more complicated because of the introduction of a third country's tax code. But a more significant problem for nomads, particularly when the host-country approach is taken throughout their careers, is a design issue: the whole is not necessarily the sum of its parts, at least when it comes to retirement benefits. That is particularly true when the plans in which an employee participates are predominantly final-average-pay plans.

Most local plans provide that final average pay will be determined as of the day an employee leaves the company sponsoring the plan, not the group of companies making up the multinational corporation. In some countries, vesting is based on local service only, as well. (In the U.S., however, ERISA requires that all service with the group be recognized for vesting purposes.) Given those facts, the pieces of benefits that a nomad accumulates throughout his or her career rarely add up to an adequate total retirement benefit.

The problem is similar to that of a U.S. national who changes jobs frequently. Under the traditional final-average-pay approach, a full career at a single company is required to accumulate an adequate retirement benefit.

Some companies have addressed the problem by providing, under each of the group's plans, that final average pay will be determined when the employee leaves the group rather than a specific company. Conceptually, that is a nice solution. Practically speaking, it often doesn't work. For example, the Inland Revenue in the U.K. (the U.K.'s IRS) has disallowed deductions to qualified plans because benefits are based on pay increases granted after the employee left the company sponsoring the plan, even though he stayed within the same group, or family, of companies. And management at one subsidiary, which had employed someone early in his career, balked at "subsidizing" pay increases granted by management at another subsidiary, which employed that person later in his career.

The chieftains

Chieftains are employees who don't necessarily move around at all during their careers. They are sometimes referred to as key local nationals (KLNs), although, again, their nationality is not all that relevant. They are highly paid employees, as a rule, whose local plans do not do an adequate job of providing retirement benefits. For example, in Brazil, local Social Security plus mandatory termination indemnities together provide adequate retirement income for just about all emloyees. For those earning in the area of $100,000 in U.S. dollars (the precise breakpoint fluctuates significantly due to the extremely volatile inflation and currency situations in Brazil) or more, however, some kind of supplementation in necessary. Similar comments apply to Italy and France. Ceilings on covered wages for Social Security purposes are one reason for that phenomenon.

Conceivably, some U.S. employees might be considered to be in this category. Examples are those who are often covered under a Supplemental Employee Retirement Plan (SERP), either because of Section 415 limits, or because of the $200,000 (as indexed) limit on covered compensation introduced by the Tax Reform Act of 1986, or perhaps because they were hired at a relatively late point in their careers and plus require some supplementation of the qualified plan benefit.

CHieftains, then, pose a different design problem: local plans don't provide an adequate benefit. Since the solution to the design problem is usually a non-qualified plan of some sort, then that solution invariably creates tax complications, similar in nature to those faced by emissaries and nomads.

The umbrella plan

The three classes of international employees all pose two generic retirement benefit challenges: complicated tax implications and a plan design problem. There is, alas, no simple solution to the tax situation. Often, the subtle tax implications of providing retirement benefits to international employees are lost in the rough-and-ready corporate world. At other times they end up being sorted out by the experts, usually the accountants who prepare the tax returns.

There are, however, solutions to the design problem. After all, it's a direct result of forcing plans meant for one purpose--to provide the right level of retirement income to standard, local employees--to serve a different purpose. Having said that, the solution seems obvious: put the globetrotters into plans designed specifically for them.

A common solution has been the "umbrella" plan. an umbrella plan is one that provides a set benefit promise, often a function of service and final average pay with the group, that is provided by the parent company. That formula is then offset by pieces of benefit accumulated in other plans during the course of an employee's career.

The questions arise: Why include the international employee in a local plan at all? Why not simply provide his or her entire benefit under an umbrella plan, or some other sort of international plan?

There are two reasons. First, in some cases, participation in the local plan is required by local law. Such is the case in Switzerland, for example. Second, umbrella plans are generally not qualified anywhere. Therefore, the tax ramifications are relatively unfavorable. Also, the security aspects, from the standpoint of the employee, may be deficient. In the U.S., for example, under ERISA, the rights and security of qualified plan participants are protected by various government agencies. Participants of non-qualified plans generally do not get that protection. The same is true in many other countries. Therefore, companies often try to maximize the participation of international employees in local plans.

Umbrella plans are often not funded. They are covered under the FASB's Statement 87; therefore, if the cost is material, it must be determined under Statement 87 and booked. Sometimes, the plans are funded by offshore trusts sited in a tax haven. A popular choice for American companies for such a set-up is Bermuda, where trusts pay minimal local taxes. European companies often look to the Channel Islands for similar reasons.

Problems with the

umbrella approach

The frustrating thing about the umbrella plan approach is the difficulty in determining the benefit to which the employee is entitled. Even at the end of a career, the task of calculating the benefit is, at best, cumbersome. Some benefit calculation entails numerous decisions about how to deal with Social Security, termination indemnities, different benefit formats (lump-sum plans, for example, are common in the Pacific Basin), exchange-rate fluctuations, and so forth. Companies that try to provide a benefit statement, perhaps 10 or 20 years in advance of retirement, are in an even more difficult quandary. Furthermore, some non-minimal percentage of employees covered under the typical umbrella plan will end up receiving no benefits because the local plans involved were on the rich side. News like that often spreads fast.

The upshot is that umbrella plans often fall short in the crucial area of credibility with employees. International employees tend to be a sophisticated, cynical lot. You tell them: "You are covered under a plan, a good plan, that will take care of you during retirement; but, sorry, we have no idea exactly how much the benefit will be." Then they notice that a colleague who retired last year didn't get anything under your same retirement plan. If the plan is not funded, that makes it even more ephemeral. A cynical reaction is not all that suprising.

Most observers feel nowadays that the defined benefit plan in general has a credibility problem. The fact that the benefit commitment is so intangible--it won't be paid for many years into the future, it will be based on pay earned in the future, its length of payment depends on how long the employee lives--causes it to be underappreciated, and undervalued, by employees. As a result, many U.S. companies have switched emphasis for U.S. employees to account balance plans, like 401(k) plans, savings plans, or cash balance plans.

In short, the umbrella plan has all the problems of the more conventional defined benefit plan, and more. And a plan that is viewed cynically by employees is counter-productive, since a primary purpose of retirement plans is to strengthen the bond between employees and the company. Some employers have reacted to this dilemma by extending the account balance approach to plans set up for international employees.

The anti-umbrella plan--one


An ideal approach to the situation is possibly a combination of the umbrella concept and the account-balance approach. Give each employee an account balance that can be reported each year in a benefit statement and that increases each year by employer contributions and investment earnings. However, have the accrual rate vary depending on the country where the employee is currently assigned. Employees in countries with rich local plans will have lower accrual rates than those in countries with no, or minical, local provision. The rates will be reviewed from time to time and determined under principles of "rough justice." Once credited, amounts will not be revised later to reflect theoretically correct offsets. Maybe it won't be exactly fair to everybody, but at least everyone will know where he or she stands.

We call this the "anti-umbrella" approach because it is really a reaction to the frustrations people have experienced with the way international plans are normally set up. It is not the sort of the theoretical solution that one would arrive at in a vacuum. To date, the anti-umbrella approach hasn't been widely adopted. However, we predict it will catch on as a good format for providing retirement benefits to international employees and, perhaps, as a good approach for that other group of KLNs--highly paid U.S. employees who have limited coverage under the U.S. qualified plan for one reason or another.

The "anti-umbrella" plan need not be funded. Funding will enhance the credibility of the plan, but it may also create unwanted tax ramifications. If not funded, then account balances could still attract investment returns. Amounts credited would be based on some easily verifiable index, such as treasury bond rates in the parent country.

In any case, it's one solution to a growing problem in the complex world of international benefits. Often, an understanding of the basic problems surrounding an issue such as retirement plans for international employees serves to lift the veil of mystery. The details and the jargon are a little less imposing, because they have some rhyme and reason.
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Title Annotation:Special Report: International
Author:Heitzman, Robert E.
Publication:Financial Executive
Date:Sep 1, 1990
Previous Article:Can your firm make it in Asia?
Next Article:Business wants realism and pragmatism.

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