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Supplemental Executive Retirement Plans (SERPs)

Supplemental Executive Retirement Plans (SERPs)

November 15, 2022

In the world of equity compensation for executives, the term SERPs may be one you hear quite often as employers seek out new ways to retain key people within their company. While Supplemental Executive Retirement Plans are grouped with other forms of equity compensation, there are differences worth drilling down to discover.

What are SERPs?

They are a set of benefits that employers make available to high-performing, top-level executives to retain and incentivize their talent. These are benefits in addition to those benefits covered by a company’s standard retirement savings plan. SERPs are a non-qualified, deferred compensation plan that carries special tax treatment for both company and executive. The money and taxes are deferred until after retirement. When the employee withdraws the money, after retirement, they would pay taxes (state and federal) on their ordinary income.

Since these plans are non-qualified, they are offered to those executives who have maxed out their annual contributions to the company-offered 401(k) plan. Like other equity compensation plans, there are eligibility requirements and vesting conditions that need to be met before the agreed upon retirement income is dispensed by an employer to an executive.

How it works?

SERPs can be funded several ways — out of a company’s current cash-flows, investment funds or through a cash-value life insurance policy.

Cash Value-Life Insurance

A cash-value life insurance is a form of permanent life insurance. It lasts the lifetime of the policyholder and features a cash-value component. The policyholder can use this cash value for any purpose — as a source of loans, for cash, or to pay policy premiums.

One example of a plan would be an annual corporate contribution equaling to a percentage of an executive’s base salary. This would vest over several years, a specific amount designated in the agreement. Another example would have a plan to provide the executive a retirement benefit — not connected with the standard retirement plan offered by the employer — that would equal 70% of the average of an executive’s three highest years of compensation.

Employer Advantages

As an employer, retaining talent is just as important as finding new talent. SERPs are one of many options that can help with that endeavor. Here are a few reasons why:

  • You can select which executives you want to reward. They are designed for that purpose.
  • SERPs are non-qualified, which means they require no approvals from the IRS and there is a limited amount of reporting.
  • The company controls the plan.
  • A life insurance policy can be purchased by the company for these key employees who are receiving a SERP. Coverage sufficient to recover any cost associated with all future benefits outlined in the agreement.
  • You can book as an annual expense equal to the present value of the stream of future benefit payments. When those benefits are paid, you can deduct them as an expense.

Employee Advantages

Of course, executives and key employees would benefit from a Supplemental Executive Retirement Plan being offered to them by their employer. These advantages include:

  • Benefits within the plan accrue without any current tax consequence
  • If a cash-value life insurance policy is used for funding, death benefits are available to provide continued supplemental payment or a lump-sum payment to the family in the event of executive’s premature death.

Disadvantages

For the company, when funding a SERP, there is no immediate tax deduction. This does not occur until the plan benefits are paid to the participant. Then, deductions are available for the company. For the executive, a life insurance policy is used to fund the SERP. Those funds accumulate unprotected against the event of any creditor claims in case of the company's insolvency. If the company fails, those funds disappear.

Contact Me for More

If you’re being presented with the option of a SERP and have more questions, please feel free to contact me through this website. Any information regarding taxes, it’s always a good idea to seek the advice of a *tax attorney.

*Representatives do not provide tax and/or legal advice. Any discussion of taxes is for general informational purposes only, does not purport to be complete or cover every situation, and should not be construed as legal, tax or accounting advice. Clients should confer with their qualified legal, tax and accounting advisors as appropriate. Securities and investment advisory services offered through qualified registered representatives of MML Investors Services, LLC. Member SIPC. Barnum Financial Group. 6 Corporate Drive, Shelton, CT 06484, Tel:(203) 513-6000

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