Supplemental Executive Retirement Plan for Top Level Executives

A Supplemental Executive Retirement Plan (SERP), also called a top hat plan, is a non-qualified retirement plan used to attract and retain key level executives in a company. The most important asset of any company is its employees and companies are always exploring ways to reward and retain their most productive executives. A SERP is a deferred compensation package offered to the top level executives in a company in the hopes that the employees will remain with the company for a longer period of time.

A deferred compensation package means that the company does not give an immediate compensation; instead it agrees to pay retirement and death benefits if certain criteria are met. A SERP plan is also a non-qualified retirement plan. A non-qualified retirement plan (as opposed to a qualified retirement plan) is not eligible for special tax treatment under IRS Code Section 401.

How Does Supplemental Executive Retirement Plan or SERP Work?

A company which is looking to implement a SERP plan will identify those employees that they wish to reward. Sometimes a Supplemental Executive Retirement Plan is also used to attract a potential employee. The employer offers to provide a supplementary retirement income to the employee subject to certain conditions. These conditions can vary, they can be employment in the company for a certain number of years and/or meeting required minimum performance levels.

There are three different ways a company can fund a Supplemental Executive Retirement Plan, through cash flows, investment funds or cash value life insurance. The third option, a cash value life insurance is the most popular of the three. The company purchases a life insurance policy on the executive's life. The policy is owned by the company and the annual premiums are paid by the company. After the employee retires, the insurance will pay the agreed upon compensation until his/her death and after the death of the employee, the insurance pays benefits either as a lump sum amount or as installments over a time period.

What are the Advantages of SERP?

There are several advantages for both the employee and employer. For the employee, a deferred compensation is attractive because the income will not be taxed at the higher tax rates which are applicable during his/her employment. Most top executives fall into a lower tax bracket after their retirement, so a deferred compensation is more tax-efficient to them. Also most conventional retirement plans have a 'reverse discrimination' in the sense that they either do not allow contribution to retirement accounts above a threshold income level or they do not give any tax benefits for contribution. For example, as per IRS the upper income limit for contribution to a Roth IRA is $177,000(for married couples filing jointly) in 2010. Therefore, a SERP plan is very advantageous to them and makes retirement planning much easier. It is also easy to custom design a Supplemental Executive Retirement Plan to suit the executive's requirements.

For employers the key benefit is of course the ability to retain their top level executives. There are several other benefits as well. The SERP plan is not offered to all the employees, instead the employers can select those executives that they wish to reward. The program is also easy to implement as the employers need not get a permission from IRS prior to implementing the plan. Also, if the company is using cash value life insurance, the company owns the policy and the cash value in the policy will grow tax deferred.

The many advantages of a Supplemental Executive Retirement Plan makes it an attractive retirement planning tool for many top level executives. Many employers are now teaming up with insurance companies to provide tailor-made SERP policies for their employees.

Posted by Mariam Anthony on Feb 2, 2009 on Suite 101.com

Fifth Street Financial Group specializes in creating compensation strategies for privately held business owners.  Call us at 408-688-6853 or email us at service@fifthstreetfinancialgroup.com to schedule a complimentary consultation.