What is a Supplemental Executive Retirement Plan?
From how they work to their advantages and disadvantages for both companies and employees, we shed some light on supplemental executive retirement plans.
Supplemental executive retirement plans compensate and retain key executives.
SERP payments are in addition to payouts from a standard retirement savings plan.
Retired executives benefit from additional payouts.
Employers receive tax deductions and may recover costs.
SERP payouts are taxable at ordinary income tax rates.
What is a supplemental executive retirement plan?
This is one of the first questions that people who come across the term ask. Also known as a SERP, a supplemental executive retirement plan is a powerful tool aimed at compensating and retaining key executives.
SERP retirement benefits are offered to top-level executives in addition to the benefits included in the company’s standard retirement savings plan.
Who is eligible for a Supplemental Executive Retirement Plan (SERP)?
Companies usually offer a supplemental executive retirement plan (SERP) to top executives. Companies can do this selectively for executives whose contributions to the company’s qualified plan are limited by income eligibility limits, maximum annual contributions, or both.
The qualified plan may be a 401(k). Sometimes, key employees who are thinking about changing companies or improving their current benefits package try to negotiate for a SERP.
High-level C-suite executives aren’t the only ones who may be eligible for this long-term incentive. A company can also offer SERP benefits to other elite employees and those with many years of experience.
How does a SERP work?
To fully understand what a supplemental executive retirement plan is, you need to know how a SERP works. Usually, the company and the executive sign an agreement promising the executive a specified amount of supplementary income based on various eligibility conditions. The executive must meet these conditions.
The company funds the plan accordingly. This can happen by the company paying the premiums of a cash-value life insurance policy or by funding the plan out of current cash flows or investment funds. The money due to the executive and the taxes on it are deferred.
When the executive retires, they will receive supplemental retirement income. The executive must pay state and federal taxes on this income just as they would on ordinary income. The company will receive a tax deduction at this time.
Let’s illustrate this with an example of how a supplemental executive retirement plan (SERP) can work for you.
Let’s say you and your employer sign a SERP retirement plan agreement that takes the form of a cash-value life insurance policy.
Your employer will buy an insurance policy of an agreed-upon amount for you, paying the monthly premiums for the duration of your time of employment. Your employer will receive tax benefits as they pay the insurance policy premiums.
When you retire, the insurance policy will pay out a taxable supplementary income. If you quit the company before retirement, your employer will still have access to the insurance policy’s cash value. If you pass away, your employer will be a beneficiary of the payout and will receive tax benefits.
What are the advantages of a SERP?
As mentioned above, the advantages or benefits of a SERP aren’t limited to the employee. A supplementary executive retirement plan can also have advantages for the company. Three of the biggest advantages include:
No approval and minimal admin required: As non-qualified plans, SERPs do not need IRS approval, and they require minimal reporting.
The company can recover its costs: The company can recover its costs if a cash-value life insurance policy is used to fund the SERP benefits. When the company uses a policy, it will benefit from tax-deferred accumulation within the policy. By structuring it correctly, the company can cover the costs it spent on the policy.
The SERP might include death benefits: An executive’s bespoke SERP can consist of death benefits if the plan is a cash-value life insurance policy. These death benefits provide a lump-sum payment or continued supplemental payments to the executive’s family in the event of the executive’s premature death.
What are the disadvantages of a SERP?
A supplemental executive retirement plan (SERP) can also have a few disadvantages. It’s important to know what these drawbacks are if you are thinking about negotiating for a SERP. Three of the biggest disadvantages include:
No protection from creditor claims: If the company becomes insolvent before the executive makes SERP withdrawals, the funds could be paid to creditors who have superseding claims.
Risk of tax disadvantages: If the executive doesn’t move into a lower tax bracket when they retire due to their already significant retirement benefits, their SERP benefits will be taxed at ordinary income tax rates. This tax rate is currently around 37% and may increase in the future.
The employee might need to meet certain conditions to receive future payouts: The executive will only receive supplemental executive retirement plan payouts if they meet certain conditions specified by the company. For example, the executive might need to work for the company for a certain number of years. If they leave the company before they retire or retire early, they will not receive any SERP payouts.
How do I navigate through a supplemental executive retirement plan?
Let’s recap what a supplemental executive retirement plan is.
A SERP can be an effective tool for offering long-term incentives to executives and longstanding employees to encourage them to remain with a company.
The executive can benefit from payments that supplement the payments from the company’s standard retirement savings plan. The company can benefit from tax deductions and potentially cover its costs when the retired executive receives SERP payments.
Finding a trusted financial advisor is the best way to start navigating your way through a supplemental executive retirement plan. Whether you’re looking at negotiating for a SERP with your employer or you want to offer the key executives at your company SERPs, a financial advisor will consider your needs and desires, working with you to create bespoke options.
Senior Content Writer
Rachel is a Senior Content Writer at Unbiased. She has nearly a decade of experience writing and producing content across a range of different sectors.