Pay-As-You-Go, as the name implies, means that no cash is specifically set aside to meet the benefit obligation, and when it becomes due it is paid from current cash flow.

For rapid growth companies with good cash flow, significant returns from invested capital, expanding operations, etc. this may be an appropriate approach. In addition it effectively transfers responsibility for the benefit program from current management to future management. To satisfy benefit obligations, the cash must be liquid at distribution. This could be a problem for companies that invest in fixed assets that don't generate cash.

For example, executives defer $1 million of current compensation that will earn 10% annually. Although the company keeps the $1 million, it is not able to deduct it as an expense until it is paid out, so its net increase in cash is $600,000 and it books $400,000 as a deferred tax asset. The executives' deferrals grow 10% the first year to $1.1 million. This additional $100,000 liability, when paid, will give the company another $40,000 in tax savings, however it increases the current net liability by $60,000. While the $1.1 million dollar liability has now accrued a $440,000 deferred tax asset, the company must still have adequate cash on hand to make the payments.

Alternatively, the company may wish to shield future management from significant liabilities by planning to accumulate assets to satisfy the future obligation and create a funding mechanism. While the company can invest in anything it wishes, two of the more popular choices are taxable securities summarized as Mutual Funds, or tax-sheltered Corporate Owned Life Insurance.


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