High-Level Executives & Retirement: Understanding SERPs
Posted by: Joseph Kuo | September 24, 2021
If you work at the executive level, you might be familiar with Supplemental Executive Retirement Plans (SERPs), a non-qualified deferred compensation plan. C-Suite executives are often offered SERPs as an additional benefit to incentivize them to stay longer 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 increased deferred retirement compensation.
Unlike other employer-sponsored retirement plans, SERPs are non-qualified and so come with their own rules, which are generally far more flexible than with IRA or 401(k) plans. Some differences between SERPs and an employer-sponsored retirement plan include:
- No IRS-defined compensation limits.
- Age of distribution may often be selected, but once selected may not be changed.
- No mandatory distributions are required by the Internal Revenue Service (IRS).
- No protection from job loss or company creditors.
- Vesting schedule might vary on case-to-case basis.
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, although the IRS does not require mandatory distributions from a SERP, a specific company’s plan might state otherwise.
When offered a SERP, executives typically must agree to these additional requirements, alongside a vesting schedule in order to be deemed eligible. The negotiating schedule can be standard for that company, or it might be negotiable. 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 are a tax deduction for the company. The structure and rules can be complicated, so 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:
- Greater control and ease of implementation.
- No IRS approval is required to establish the plan.
- Predictable cost recovery through the structure of the life insurance policy.
Executives also see benefits from this form of SERP, including:
- 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.
Typically SERPs trade flexibility in rules in exchange for fewer protections for the employee. As a non-qualified plan, SERPs are not protected from creditors or job loss.1 Assets are not transferable to tradition retirement accounts such as IRAs, and may be impacted in case of company insolvency.
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, your financial advisor can provide some guidance or resource materials that can help you understand how the plans work.