CHAPTER 9
Discretionary Benefits
Learning Objectives
9-1. Discuss the origins of discretionary benefits.
9-2. Explain the three categories of discretionary benefits.
9-3. Summarize legislation that pertains to discretionary benefits.
9-4. Discuss the fundamentals of designing and planning the benefits program.
9-5. Explain the benefits and costs of discretionary benefits.
Outline
I. Origins of Discretionary Benefits
II. Categories of Discretionary Benefits
III. Legislation Pertinent to Discretionary Benefits
IV. Designing and Planning the Benefits Program
V. The Benefits and Costs of Discretionary Benefits
VI. Key Terms
VII. Discussion Questions and Suggested Answers
VIII. End of Chapter Case; Instructor Notes, and Questions and Suggested Student Responses
IX. Crunch the Numbers! Questions and Suggested Student Responses
X. Assisted-graded Questions
XI. Additional Cases from the MyManagementLab Website; Instructor Notes, Questions and
Suggested Student Responses
Lecture Outline
I. Origins of Discretionary Benefits
1. Firms have offered a tremendous number of both legally required and discretionary
benefits
2. Retirement plans appeared as one of the first signs of discretionary benefits with first plan
offered in 1759 to benefit widows and children of Presbyterian ministers
3. Growth in 1940s in response to government-imposed wage freezes
a. Companies began to offer welfare practices, anything for the comfort and
improvement, intellectual or social, of employees
4. Unions directly contributed to increase in welfare practices through National Labor
Relations Act of 1935 (NLRA)
a. Legitimized bargaining for employee benefits
b. Nonunion employers offered similar benefits in attempt to keep unions out
5. Increasing workplace diversity has led to more flexible benefit offerings
II. Categories of Discretionary Benefits
A. Protection Programs
1. Disability insurance
a. Replaces income when employee becomes hurt or ill
b. Short-term disability provides benefits for a limited time, usually less than six months
i. Most short-term disability plans pay between 60 to 70 percent of their pretax
salary
ii. Insurance companies may impose preexisting conditions to limit their liabilities
iii. Two waiting periods
Pre-eligibility period spans from the initial date of hire to the time of
eligibility for coverage
Elimination period refers to the minimum amount of time an employee must
waist after becoming disabled before disability insurance payments begin
iv. Exclusion provisions list the particular health conditions that are ineligible for
coverage
c. Long-term disability provides benefits for extended periods between 6 months and
life
i. Payments generally equal a fixed percentage of pre-disability earnings, most
typically 50 to 60 percent
ii. Initially refers to illnesses or actions that prevent employee from performing their
‘own occupation’
iii. Eventually refers to ‘any occupation’
iv. Also includes preexisting condition and exclusion clauses
2. Life insurance
a. Pays employees’ beneficiaries upon employee’s death
b. Pays a multiple of the employee’s salary
c. Three kinds
i. Term life insurance
ii. Whole life insurance
iii. Universal life insurance
d. Term life insurance provides income to employee’s beneficiaries only during a
limited period based on a specified number of years subject to a maximum age
e. Whole life insurance pays an amount to the designated beneficiaries and does not
terminate until payment is made to beneficiaries
f. Universal life insurance provides more flexible savings or cash accumulation plan
than whole life insurance plans
3. Retirement programs
a. Provide income to employees and their beneficiaries during some or all of their
retirement
b. Defined benefit plans (pension plans) guarantee retirement benefits specified in the
plan document
i. Expressed in terms of monthly sum equal to a percentage of a participant’s
preretirement pay multiplied by the number of years he or she has worked for the
employer
c. Defined contribution plans allow employees the option to make regular contributions
to separate accounts in their names, based on a formula contained in the plan
document
i. Employers contribute money in form of company match
ii. Internal Revenue Code (IRC) is the body of tax regulation in the U.S. and sets
the annual contribution amounts to these plans on a pretax basis
iii. The annual maximum allowable contribution to a participant’s account is the
annual addition
iv. Private sector Section 401(k) plans are named for the section of the IRC that
created them
v. Roth 401(k) plans are similar to 401(k) plans but employee contributions are
taxed at the individual’s income tax rate and upon retirement, employee
withdrawals are not taxed
vi. Section 403(b) plans are offered to employees of government and tax-exempt
groups
vii. Section 457 plans apply to state government employees
d. Profit sharing plans distribute money to employees
i. Current profit sharing plans award employees with a share of the company’s
profits
ii. Deferred profit sharing plans set aside money in employee accounts for use in
retirement
e. Hybrid plans combine features of traditional defined benefit and defined contribution
plans
i. Cash-balance plans are the most common hybrid plan
B. Paid Time Off
1. Compensates employees when they are not performing their primary work duties
2. Major types:
a. Holidays
b. Vacation
c. Sick leave
d. Personal leave
e. Jury duty
f. Funeral leave
g. Military leave
h. Clean-up, preparation, or travel time
i. Rest period “break”
j. Lunch period
k. Integrated time off policies
l. Sabbatical leave
m. Volunteerism
3. Helps employee balance work and non-work activities
4. Can reduce absenteeism and improve productivity
5. Integrated time off policies
a. Combine holiday, vacation, sick leave, and personal leave policies into a single paid
time off policy
b. Provide individuals the freedom to schedule time off without justifying the reasons
c. Relieve the administrative burden of managing separate plans and the necessity to
process medical certifications in the case of sick leave policies
d. Bereavement or funeral leave are not included because the death of a friend or
relative is typically an unanticipated event beyond an employee’s control
6. Sabbatical leave
a. Paid time off for such professional activities as a research project or curriculum
development
b. Common in college and university settings and apply most often to faculty members
7. Volunteerism
a. Refers to giving of one’s time to support a meaningful cause
b. Companies are providing employees with paid time off to contribute to causes of
their choice
c. Companies favor providing paid time off for volunteer work for three reasons:
i. First, volunteer opportunities allow employees to balance work and life demands
ii. Second, giving employees the opportunity to contribute to charitable causes on
company time represents positive corporate social responsibility, enhancing the
company’s overall image in the public eye
iii. Third, paid time off to volunteer is believed to help promote retention
C. Services
1. Employee assistance programs
a. Help employees cope with such personal problems that may impair their job
performance such as alcohol or drug abuse, domestic violence, the emotional impact
of diseases, clinical depression, and eating disorders
b. Annual cost per employee of an EAP is approximately $50 to $60
c. Employers’ gains outweigh their out-of-pocket expenses for EAPs due to reduced
costs of turnover, absenteeism, medical costs, unemployment insurance rates,
workers’ compensation rates, accident costs, and disability insurance costs
2. Family assistance programs
a. Help employees provide elder care and child care
b. Elder care provides physical, emotional, or financial assistance for aging parents,
spouses, or other relatives who are not fully self-sufficient because they are too frail
or disabled
c. Child care programs focus on supervising preschool-age dependent
d. Flexible scheduling and leave allows employees the leeway to take time off during
work hours to care for relatives or react to emergencies
e. Day care is a benefit where companies subsidize child or elder day care in
community-based centers
3. Tuition reimbursement
a. Employer fully or partially reimburses an employee for expenses incurred for
education or training
b. Employees choose the courses they wish to take, when they want to take them, and
may enroll in courses that are not directly related to their work
c. Pay increases are not directly associated with tuition reimbursement programs
4. Transportation services
a. Help bring employees to the workplace and back home again by using more
energy-efficient forms of transportation
b. Sponsor public transportation or vanpools: employer-sponsored vans or buses that
transport employees between their homes and the workplace
c. Provide transit subsidies to employees working in metropolitan and suburban areas
served by mass transportation (e.g., buses, subways, and trains)
5. Outplacement assistance
a. Provides technical and emotional support to employees who are being laid off or
terminated
b. Variety of career and personal programs designed to develop employees’ job-hunting
skills and strategies and to boost employees’ self-confidence
c. Those best suited to outplacement assistance programs include:
i. Layoffs due to economic hardship
ii. Mergers and acquisitions
iii. Company reorganizations
iv. Changes in management
v. Plant closings or relocation
vi. Elimination of specific positions, often the result of changes in technology
d. Promote a positive image of the company among those being terminated, as well as
their families and friends, by helping these employees prepare for employment
opportunities
6. Wellness programs
a. Promote and maintain employees’ physical and psychological health
b. Must not make a condition of employment
c. May emphasize weight loss, smoking cessation, and cardiovascular fitness
d. Smoking cessation plans range from simple campaigns that stress the negative
aspects of smoking to intensive programs directed at helping individuals to stop
smoking
e. Stress management programs help employees cope with many factors inside and
outside work that contribute to stress
f. Weight control and nutrition programs educate employees about proper nutrition and
weight loss, both of which are critical to good health
7. Financial education
a. Provides employees with the resource for managing personal budgets and long-term
savings (e.g., for retirement)
b. Relatively low cost benefit that helps employees plan current and future (retirement)
budgets
III. Legislation Pertinent to Discretionary Benefits
A. Internal Revenue Code
1. The Internal Revenue Code (IRC) is a set of regulations pertaining to taxation in the
United States
2. The Internal Revenue Service (IRS) is the government agency that develops and
implements the IRC and levies penalties against companies and individuals who violate
the IRC
3. The government encourages employers to offer retirement plans by offering tax breaks or
deductions
4. The IRC also permits employees to make contributions to benefits such as health care and
retirement plans on pretax basis
B. Employee Retirement Income Security Act of 1974 (ERISA)
1. Established to regulate the implementation of various employee benefits programs,
including medical, life, and disability programs, as well as pension programs
2. Addresses matters of employers’ reporting and disclosure duties, funding of benefits, the
fiduciary responsibilities for these plans, and vesting rights
3. Provisions set minimum standards required to qualify pension plans for favorable tax
treatment
a. Qualified plans entitle employers and employees to substantial tax benefits
b. Nonqualified plans refer to pension plans that fail to meet at least one of the
minimum standard provisions
4. Participation requirements: Employees must specifically be allowed to participate in
pension plans after they have reached age 21 and have completed 1 year of service (based
on 1,000 work hours)
5. Coverage requirements limit the freedom of employers to exclude employees
6. Vesting refers to an employee’s nonforfeitable rights to retirement plan benefits
a. Employees are always vested in their contributions to pension plans
b. Cliff vesting: Must grant employees 100 percent vesting after no more than 3 years
of service
c. 6-year graduated schedule: Allows workers to become 20 percent vested after 2 years
and to vest at a rate of 20 percent each year thereafter until they are 100 percent
vested after 6 years of service
7. Nondiscrimination rules: Prohibit employers from discriminating in favor of highly
compensated employees in contributions or benefits, availability of benefits, rights, or
plan features
C. Pension Protection Act of 2006
1. Designed to strengthen employee rights and is an amendment to ERISA
2. Defined benefit plans
a. Strengthens the condition of the Pension Benefit Guaranty Corporation which is a
self-financed corporation established by ERISA to insure private-sector defined
benefit plans
3. Defined contribution plans
a. Makes it easier for employees to participate by allowing companies to enroll
employees automatically and providing greater access to professional advice about
investing for retirement
IV. Designing and Planning the Benefits Program
A. Benefits can work strategically by offering protection programs, paid time off, and services
1. Companies can involve employees in benefits determination process using surveys,
interviews, and focus groups
2. Design issues include:
a. Who receives coverage
b. Financing of benefits
c. Employee choice
d. Cost containment
e. Communication
B. Determining Who Receives Coverage
1. Must decide if company should extend benefits to part-time employees
2. Some companies withhold benefits during the probationary period which is the initial
term of employment (usually less than 6 months)
C. Financing
1. Noncontributory financing implies that the company assumes total costs for each
discretionary benefit
2. Contributory financing exists when the company and its employees share the costs
3. Employee-financed benefits exists when employers do not contribute to the financing of
discretionary benefits
D. Employee Choice
1. Human resources professionals must decide on the degree of choice employees should
have in determining the set of benefits they will receive
2. Flexible benefits plans or cafeteria plans allow Employees within a company to choose
from among a set of benefits, as opposed to all employees receiving the same set of
benefits
3. Core plus option plans extend a preestablished set of such benefits as medical insurance
as a program core, which is usually mandatory for all employees
E. Cost Containment
1. Due to rising health care costs, employee benefits account for a substantial percentage of
total compensation costs
2. Employers face difficult trade-offs between employee benefits offerings and increases in
core compensation
F. Communication
1. Employees often are unaware of the value of benefits so companies should try to convey
to employees the value they are likely to derive from having such benefits
2. A personal benefits summary is a useful approach
3. An effective communication program should have three objectives
a. Create an awareness of and appreciation for the financial security and well-being of
employees
b. Provide an understanding about available benefits
c. Encourage wise use of benefits
V. The Benefits and Costs of Discretionary Benefits
A. Overview
1. Discretionary benefits can promote competitive advantage
2. Discretionary benefits can also undermine the imperatives of strategic compensation
3. Companies that provide discretionary benefits as entitlements are less likely to promote
competitive advantage than companies that design discretionary fringe compensation
programs to fit the situation
4. Discretionary benefits offerings can promote particular employee behaviors that have
strategic value
5. Discretionary benefits can distinguish a company from its competition
6. Discretionary benefits have tax advantages
a. Can translate into cost savings
b. Companies pursuing differentiation strategies might invest more in research and
development
c. Companies pursuing lowest cost strategies might be able to lower prices
End of Chapter
VI. Key Terms
Welfare practices: Anything for the comfort and improvement, intellectual or social, of the employees,
over and above wages paid, which is not a necessity of the industry nor required by law
Short-term disability insurance: Provides benefits for a limited time, usually less than 6 months
Long-term disability insurance: Provides benefits for extended periods between 6 months and life
Short-term disability: An inability to perform the duties of one’s regular job
Preexisting condition: A mental or physical disability for which medical advice, diagnosis, care, or
treatment was received during a designated period preceding the beginning of disability insurance
coverage
Preeligibility period: Spans from the initial date of hire to the time of eligibility for coverage in a
disability insurance program
Elimination period: Refers to the minimum amount of time an employee must wait after becoming
disabled before disability insurance payments begin
Exclusion provisions: List the particular health conditions that are ineligible for coverage
Long-term disability: Initially refers to illnesses or accidents that prevent an employee from performing
his or her “own occupation” over a designated period
Life insurance: Protects employees’ families by paying a specified amount to an employee’s
beneficiaries upon the employee’s death
Term life insurance: Provides protection to employees’ beneficiaries only during a limited period based
on a specified number of years (e.g., 5 years) subject to a maximum age (e.g., 65 or 70)
Whole life insurance: Pays an amount to the designated beneficiaries of the deceased employee, but
unlike term policies, whole life plans do not terminate until payment is made to beneficiaries
Universal life insurance: Combines features of term life insurance and whole life insurance
Retirement programs: Provide income to employees and their beneficiaries during some or all of their
retirement
Pension plan: A defined benefit retirement plan
Defined benefit plans: Guarantee retirement benefits specified in the plan document
Defined contribution plans: Employees have the option to make regular contributions to separate
accounts in their names, based on a formula contained in the plan document
Company match: When employers contribute money to defined contribution plans
Internal Revenue Code (IRC): The body of tax regulation in the United
States, sets annual contribution amounts to these plans on a pretax basis
Annual addition: Refers to the annual maximum allowable contribution to a participant’s account in a
defined contribution plan
Section 401(k) plans: Retirement plans named after the section of the IRC that created them
Roth 401(k) plans: Similar to 401(k) plans, but employee contributions are taxed at the individual’s
income tax rate and upon retirement, employee withdrawals are not taxed
Section 403(b) plans: Retirement plans offered to employees of government and tax-exempt groups,
such as schools, hospitals and churches
Section 457 plans: Retirement plans that apply to state government employees
Profit sharing plans: (Current) plans award employees with a share of the company’s profits, usually on
an annual basis
Deferred profit sharing plans: Set aside money in employee accounts for use in retirement
Hybrid plans: Combine features of traditional defined benefit and defined contribution plans
Cash-balance plans: Structured as “defined benefit plans that define benefits for each employee by
reference to the amount of the employee’s hypothetical account balance”
Integrated paid time off policies: Combine holiday, vacation, sick leave, and personal leave policies
into a single paid time off policy
Paid time off banks: Combine holiday, vacation, sick leave, and personal leave policies into a single
paid time off policy
Sabbatical leaves: Paid time off for such professional activities as a research project or curriculum
development
Volunteerism: Refers to giving of one’s time to support a meaningful cause
Employee assistance programs (EAPs): Help employees cope with such personal problems that may
impair their job performance as alcohol or drug abuse, domestic violence, the emotional impact of AIDS
and other diseases, clinical depression, and eating disorders
Family assistance programs: Help employees provide elder care and child care
Flexible scheduling and leave: Allows employees the leeway to take time off during work hours to care
for relatives or react to emergencies
Day care: Subsidized child or elder day care in community-based centers
Tuition reimbursement programs: The employer fully or partially reimburses an employee for
expenses incurred for education or training
Transportation services: Programs that help bring employees to the workplace and back home again by
using more energy-efficient forms of transportation
Outplacement assistance: A variety of career and personal programs designed to develop employees’
job-hunting skills and strategies and to boost employees’ self-confidence that are provided to employees
that are laid off
Wellness programs: Promote and maintain employees’ physical and psychological health
Smoking cessation: Range from simple campaigns that stress the negative aspects of smoking to
intensive programs directed at helping individuals to stop smoking
Stress management: Help employees cope with many factors inside and outside work that contribute to
stress
Weight control and nutrition programs: Designed to educate employees about proper nutrition and
weight loss, both of which are critical to good health
Employee Retirement Income Security Act of 1974 (ERISA): Established to regulate the
implementation of various employee benefits programs, including medical, life, and disability programs,
as well as pension programs
Qualified plans: Entitle employers and employees to substantial tax benefits
Nonqualified plans: Refer to pension plans that fail to meet at least one of the minimum standard
provisions
Participation requirements: Employees must specifically be allowed to participate in pension plans
after they have reached age 21 and have completed 1 year of service (based on 1,000 work hours)
Coverage requirements: Limit the freedom of employers to exclude employees
Vesting: Refers to an employee’s nonforfeitable rights to retirement plan benefits
Cliff vesting: Must grant employees 100 percent vesting after no more than
3 years of service
6-year graduated schedule: Allows workers to become 20 percent vested after 2 years and to vest at a
rate of 20 percent each year thereafter until they are 100 percent vested after 6 years of service
Nondiscrimination rules: Prohibit employers from discriminating in favor of highly compensated
employees in contributions or benefits, availability of benefits, rights, or plan features
Pension Benefit Guaranty Corporation (PBGC): A self-financed corporation established by ERISA to
insure private-sector defined benefit plans
Probationary period: Employees’ initial term of employment
Noncontributory financing: Implies that the company assumes total costs for each discretionary benefit
Contributory financing: The company and its employees share the costs
Employee-financed benefits: Employers do not contribute to the financing of discretionary benefits
Flexible benefits plan: Employees within a company can choose from among a set of benefits, as
opposed to all employees receiving the same set of benefits
Cafeteria plan: Employees within a company can choose from among a set of benefits, as opposed to all
employees receiving the same set of benefits
Core plus option plans: Extend a preestablished set of such benefits as medical insurance as a program
core, which is usually mandatory for all employees