At Capital Fiduciary Advisors we are often asked for insight, analysis and opinion on SERPs. Here is a brief piece we wanted to share that we hope can benefit others in idea exchange and thinking through a strategy. A Supplemental Executive Retirement Plan, or SERP, is a non-qualified deferred compensation plan offered to key executives. C-Suite executives are often offered SERPs as an additional benefit to incentivize long-term employment at a company.
SERPs possess unique restrictions, benefits and disadvantages when compared to other retirement plans. In this article, we will explore some of these features to better understand the function of SERPs.
How Do SERPs Work?
Employee retention is a key goal of most companies. Competitive compensation and enticing benefits are an important part of maintaining high-level employees long-term.
For executive roles, SERPs act as a form of retention, incentivizing long-term employment in return for deferred retirement compensation. Unlike other employer-sponsored retirement plans, SERPs are non-qualified and possess their own rules.
Some differences between SERPs and an employer-sponsored retirement plan include:1
- SERPs may be offered to select employees.
- No IRS defined compensation limits.
- Age of distribution may often be selected, but not changed.
- No mandatory distributions are required by the Internal Revenue Service (IRS).
- No protection from job loss or company creditors.
This list of differences is not exhaustive, though it should be noted that additional restrictions and requirements may be established by the company. For example, the IRS does not require mandatory distributions from a SERP, though a specific company's plan may state otherwise.1
When offered a SERP, executives typically must agree to these additional requirements, alongside a vesting schedule in order to be deemed eligible.
The SERP is then funded by the company in a number of ways, including but not limited to:
- Cash flow
- Investment funds
- Cash-value life insurance
The deferred benefits established by the plan are not taxable until the plan is paid, at which point payments are treated as taxable income for the executive and a tax deduction for the company.
Consult with your tax, legal and accounting professionals if you are included in your company’s SERP.
The Benefits of a SERP
It’s common for companies to utilize a cash value life insurance policy to fund their SERP.2 This provides benefits to both the company and the executive employee.
Companies often use this form of SERP for a few benefits, including:2
- Greater control and ease of implementation.
- No IRS approval is required to establish the plan.
- Cost recovery through the structure of the life insurance policy.
Executives also see benefits from this form of SERP, including:2
- Tax benefits both before and after the plan is paid.
- Adjustable plan structure.
Disadvantages of a SERP
Companies and employees are attracted to SERPs for a number of reasons, but this does not mean that SERPs do not possess disadvantages.
In most cases, these disadvantages come in the form of protection. As a non-qualified plan, SERPs are not protected from creditors or job loss.1 Assets will not transfer to an IRA and may be used in the case of company insolvency.1
The information in this article is designed to provide a general understanding of SERPs, providing both advantages and disadvantages to the plan. If you are offered a SERP, we can provide some guidance or resource materials that can help you understand how the plans work.
Please call or write if we can be a resource to you or friends who may be able to benefit.
All the best,
Chris Williams, President & CEO
This content is developed from sources believed to be providing accurate information, and provided by Capital Fiduciary Advisors. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security.