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The FedEx Cup: Where Birdies Become Annuities

You needn’t have a Ph.D. to understand the PGA Tour’s FedEx Cup points system, which was used to formulate the field for this year’s first-ever, year-end “playoffs” to crown the Tour’s inaugural Cup “champion.” But it wouldn’t hurt. And an underpinning of the Tour’s latest marketing endeavor does require at least a rudimentary understanding of retirement planning, the federal tax system, and the mathematical rationale behind “deferred compensation.”

The Tour’s “regular season” began in January and ended with last week’s Wyndham Championship. You may not have realized it, but two sets of standings were being compiled during the year (in addition to the President’s and Ryder Cup player standings): the Tour’s official money list, i.e. the traditional marker of successful play; and the newly instituted FedEx Cup points standings. Only the FedEx standings truly matter in regards to the “playoffs,” which started with this past weekend’s Barclays sponsored event won by Steve Stricker. Ironically, it’s a system that the players themselves readily admit is a cryptic nightmare.

But it’s simple, really. After the Wyndham, the top 144 players on the FedEx points list advanced to a four-week, four-tournament “playoff.” Before The Barclay’s began, the points list was reset, with each player seeded according to his regular-season finish. For instance, Tiger Woods finished with 30,574 points, to second-place finisher Vijay Singh’s 19,129 and third-place finisher Jim Furyk’s 16,691 points. However, after the reset, Tiger had 100,000 points, to Vijay’s 99,000 and to Furyk’s 98,500. Beginning with The Barclay’s, and continuing through the final four events (this coming week’s Deutsche Bank Championship; the BMW Championship; and the Tour Championship) 50,000 points are up for grabs weekly, and at each tournament a predetermined number of players who have accumulated the fewest points are eliminated. Thus, the playoff “field” continues to shrink each week, from 144, to 120, to 70, and finally to 30.

Finally there is the subject of prize money—the issue where players and their agents’ ears perk up. Historically, a player’s sponsorship and marketing revenue (from which agents largely make their commissions and earn their livelihood) has directly correlated with how he finished on the previous year’s money list. With the advent of the FedEx Cup standings, that calculation may change, and thus agents are best served with being well-versed on how the $35 million FedEx Cup “pot” will distributed. It works as follows: the top 150 players on the regular-season points list will split the pot (yes, very strangely, six players who don’t even qualify for the playoffs will get paid), such that $10 million will be awarded to the champion (the largest single bonus payout in sports), and second-place will receive $3 million, all the way down to $32,000 (note that the top-70 finishers are guaranteed at least a six-figure amount). But there is a highly controversial wrinkle to the payout scheme. FedEx cup pot money (which is separate from the purse money of $7 million, up for grabs at each individual playoff tournament) will be deferred, such that it will go into an individual player’s retirement account that cannot be accessed until he turns 45. “I may be dead by that time,” quipped Tiger.

What gives? Many Tour players are upset by the concept of deferred compensation (as a financial vehicle, it is called an ‘annuity’). Phil Mickelson noted that it “takes some of the luster” out of the FedEx Cup, and Trevor Immelman said that he’d “probably rather have the money now.” But according to Golfweek’s Adam Schupak, these sentiments are short-sighted at best, and moreover, “the best retirement plan in sports just got better.” Schupak wrote two insightful columns in recent editions of Golfweek describing the history and the details of the Tour’s performance-based retirement plan, and also how the financial largesse of the FedEx Cup only adds to Tour players’ long-term fiscal security. Below are some key points Schupak hits on:

• The plan was conceived by former Tour commissioner Deane Beman, and approved by the Internal Revenue Service (IRS) in 1983.

• The plan once rewarded players under three distinct options: the “cuts” plan, which features a deferred compensation credit value of $3,700 that doubled after the 15th tournament cut made; the “incentive” plan, which divided the season into three segments and allowed players to “earn” contributions based on their rank in an adjusted money list; and finally a “bonus” plan, that rewarded a player’s finish on the money list and allowed varying contributions based on his year-end standing.

• However, because marquee players such as Woods and Mickelson played (and still play) largely reduced schedules, they were permitted to vest only at 62%, rather than at 100% because they failed to meet the vesting requirements of the “incentive” plan. In other words, in principle the very guys generating the lion’s share of the Tour’s sponsorship and television dollars were getting “short-changed” (albeit by their own volition) when it came to their retirement accounts.

• “Qualified” plans, such as the ones used by Major League Baseball and other major professional sports leagues, have funding limits determined by the IRS (up to $44,000 in 2006), because said players are considered “employees” of their respective leagues. However, because Tour players are considered “independent contractors,” the Tour wasn’t eligible to offer a qualified plan, and instead offered a “non-qualified plan,” through which a player like Woods was able to stow away close to $700,000 last year, while the average contribution was $195,000! Yet this vast discrepancy makes some sense. As Joe Ogilvie, one of the four player directors of the Tour’s nine-member policy board notes, “We have the most unpredictable job in sports from a tax standpoint…the Tour’s retirement plan gives [us] a sense of financial security.”

• Under the FedEx Cup, both the “incentive” and “bonus” plans have been eliminated, and Tour executives instead combined the $16.5 million from these two programs with $18.5 million accrued in relation to the sponsorship deal with FedEx (creating the $35 million FedEx Cup “pot” listed above).

• The Tour policy board ultimately determined that a deferred compensation structure was “in the best long-term interest of the vast majority of players.” As Schupak illustrates, “deferred compensation enables money to grow tax-free until players draw upon it, no earlier than age 45, and simple math illustrates the advantage.” If Woods wins the $10 million as an immediate cash prize, for example, he is taxed at 35% by the federal government (3.5 million). But via deferred compensation, said 3.5 million instead will grow to more than $28 million (assuming 8% interest, money doubling every nine years, and that Woods remains active as a player and does not draw from the account until he is 60, the latest age he may defer).

So what’s the bottom-line? According to Dave Lightner of FSM Capital, a Cleveland-based financial firm, “you could easily see guys [ultimately] with $250-300 million in a retirement account.” Moreover, Schupak writes that “this year, the PGA Tour’s contributions to the player’s retirement fund is expected to reach $47 million, up from $28.5 million last year and nearly nine times the amount when Woods first joined the Tour in 1996. Thus, while the FedEx Cup may make fans and players alike scratch their heads, and may fail to ever truly pique Tiger’s interest (he skipped The Barclay’s citing fatigue; however, he was assured of advancing to the next round regardless), the concept puts even more money into Tour players’ pockets, albeit under a deferred timeframe. And for the Tiger’s and Phil’s of the world, it means an even larger long-term nest egg, while allowing them to keep the same reduced schedule that gives some PGA tournament directors headaches, but keeps the elite players fresher off the course, and able to pursue more corporate relationship, sponsorship and course-design possibilities. Which makes their agents smile broadly.


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9 replies on “The FedEx Cup: Where Birdies Become Annuities”

Awesome post, hopefully this will really clear things up for the players, fans and media that haven’t taken the time to truly understand the incredible opportunity that lies with the Fedex Cup.

The tax deferred strategy is ultimately a zero sum game for players who do not need to dip in their non-qualified accounts.

Your example about Tiger allowing his $10M to grow to $28M in 30 years tax deferred (at which point he must withdraw at age 60) is flawed. If Tiger allowed his money to double every 9 years for 27 years, that $10M would be $80M — minus 35% when he withdraws leaves $52M

If Tiger took his $10M and paid his $3.5M in taxes now, he’d have $6.5M to invest. Double every 9 years for 27 years = $52M. The math is the same. In fact, by cashing out now, Tiger will not be subject to restrictions on investments that are surely in place within the plan…and at capital gains rates (15%) going forward.

Such tax deferred plans were enacted to encourage workers to contribute and save for their retirement, to cut their dependence as retirees on Social Security. Surely, Tiger will not have to worry about funding his retirement.

This is a way for FedEx and the other sponsors to fund the payout using an annuity and hopefully out-perform the market in the interim, much the way life insurance and lottery payouts work. It is yet another hedge for these corporations.

“In fact, by cashing out now, Tiger will not be subject to restrictions on investments that are surely in place within the plan…and at capital gains rates (15%) going forward.”

I agree – I can make that money work harder for me now (sorry, if I’m Tiger I can have my accountants make that money work harder) than it can sitting in a retirement plan.

Have to run, time to hit the putting green. After seeing this, I’ve got a Tour Card I need to win.

Big dog:

Good point about FexEx’s motivation and hedging.

Not sure what the restrictions on the FedEx plan are, but I believe any amount over $5 million may be used towards any kind of security.

Also, you’re assuming that the deferred payment is ultimately distributed as a lump-sum and not annuitized. If you annuitize, part of each payment is considered as a return of previously taxed principal (i.e., your investment) and part as earnings. You will owe income taxes on the part of the payment that’s considered earnings. The amount of each payment that won’t be taxed is computed by establishing an “exclusion ratio” that’s determined by dividing your investment in the contract by the total amount you expect to a receive during the payout period.

IRS Publication 939 (General Rule for Pensions and Annuities) highlights the details on how to calculate taxes due on annuity payments. Per their illustration, assume you have a fixed annuity in which you’ve invested $100,000 that will pay you a sum of $750 per month for life starting at age 62. According to IRS life expectancy tables, you will receive those payments for 22.5 years, so your contract’s value is $202,500 (12 X $750 X 22.5). Your exclusion ratio is 49.4% ($100,000/$202,500). Therefore, out of the $9,000 the annuity pays each year, you may exclude $4,446 from income. The remaining $4,554 of that payment will be subject to ordinary income taxes.

So in that case the math is NOT the same.

The main point is that guys not named Tiger have a much larger retirement pot now. Plus, if the FedEx money was paid out immediately, there’s no guarantee it would be used by the recipients towards their retirement. For some guys (here’s looking at you, John Daly), a mechanism to insure (and indeed require) their long-term financial well being may be welcome. For other financially astute investors, they may indeed be able to garner a better return by taking an immediate tax hit. But they’d also be welcoming market uncertainty (a primary knock against Bush’s private SS accounts) and inviting taxes on capital gains and reinvested dividends along the way. Thus, yes theoretically the immediate after-tax amount of 6.5 in the example could turn into 52 over time. But there is no guarantee, and more often than not, a risk averse investor may be better off taking the guaranteed non-taxed accumulation rather than trying to duplicate that return through an uncertain market.

To that extent, most golfers by all accounts are risk AVERSE personalities (they play the percentages on the course, so it’s not surprising they’d do so off the course), so I’m not surprised that the FedEx plan was eventually embraced by the Tour policy board (though as you point out, there are certainly valid strikes against it).

Let’s not forget that the capital gains rate of 15% expires on Jan. 1 of 2010 (I’m pretty sure that is the year) and there is no telling what the congress will do with tax. They could potentially do away with the capital gains rate completely and if someone was looking at their potential tax bill 20 years down the road that 5 or 10 percent extra would translate into a lot of money. I doubt that the capital gains rate would be done away with because of the incentive it provides to invest but an increase in the amount is not out of the question.

Someone correct me if I’m wrong, but I think In 2011 the 15% rate will “sunset,” or revert to the rates in effect before 2003, which were generally 20%.

In summary, the point above that the after-tax 6.5 will definitely yield the same $52 mil of the after-tax, lump sum distributed annuity omits the following two points: (1) only an annuity will allow you to escape the double taxation (annual capital gains/dividend taxes, plus the ultimate taxation at the point of redemption) and (2) only an annuity guarantees that non-taxed ROI, whereas market uncertainty dictates that your return on a non-annuity vehicle may fluctuate. Thus, even if you put the post-tax 6.5 into an annuity, you’d pay taxes again on the date of withdrawal!

And while a guy with Tiger’s annual net income may find an annuity too conservative of a retirement vehicle, let’s remember that Tiger’s annual income eclipses that even of the #2 guy in the income rankings, Phil Mickelson’s. So the FedEx annuity is really geared towards the stuggling journeymen pros who are fighting just to keep their Tour cards and make six figures. You know, all of the guys who aren’t necessarily ringing the bell at the NYSE…

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