It’s often difficult for highly compensated executives to save enough money in a traditional 401(k) plan to maintain their current living standards. Fortunately, companies can offer highly sought-after executives a retirement plan that not only offers a more comfortable retirement, but also is a powerful enticement to stay with the company.
A Supplemental Executive Retirement Plan (SERP) is a non-qualified retirement plan for key employees who fall outside Employee Retirement Income Security Act (ERISA) guidelines. The company signs an agreement promising the executive a certain supplemental retirement income based on vesting and other eligibility conditions. In a typical plan arrangement, the company funds the SERP with cash flow, investment funds or cash-value life insurance. The executives have the opportunity to earn benefits equal to 70 percent of the high, three-year average compensation.
The most common way a company funds a SERP is by purchasing a cash-value life insurance policy. The company pays the premiums and is the policy beneficiary, and the policy’s cash value grows tax deferred. When executives retire, they receive an income paid by the company using the policy’s cash value. If the executive dies before retirement, the company is the beneficiary and can use the benefit as it sees fit.
SERPs are fairly easy to set up. A SERP and insurance policy can be tailored to an executive’s needs, and the benefits accrue to the executive without any tax consequences until an income is paid.
With a cash-value life insurance policy, the value accumulates tax deferred. When benefits are paid, the executive pays the taxes on the income and the company deducts them as an expense. If the employee quits, the company still has access to the policy’s cash value. The plan usually is structured in a manner that lets the company recover its cost.