A supplemental executive retirement plan (SERP) can be a highly effective way to provide additional compensation for a handful of key employees and persuade them to remain with the company longer. A SERP has numerous advantages both for the business and its key employees.
Supplemental retirement income funded by a life insurance policy
Although SERPs could be paid out of cash flows or investment funds, most are funded through a cash value life insurance plan. The employer buys the insurance policy, pays the premiums, and has access to its cash value. The employee receives supplemental retirement income paid for through the insurance policy. Once the employee receives income in retirement, that benefit is taxable. At that point, the employer receives a tax deduction.
Numerous benefits for the business and employee
SERPs are attractive to employers. They’re easy to implement, they don’t require IRS approval, and organizations can decide which employees will receive this benefit. The employer can structure the life insurance policy in a way that allows the company to recover its cost.
Employees benefit from receiving a supplemental retirement benefit that is only taxable when they receive income in retirement. At that point, most executives will be in a lower tax bracket than when working. The plan can be tailored to meet the specific needs of individual employees.
Design: Defined benefit or defined contribution?
There are a variety of possible SERP designs. Most commonly, they are designed either as defined benefit or defined contribution plans.
A defined benefit SERP provides a benefit in the form of an annuity at retirement. When added to the employee’s projected income from the qualified retirement plan and Social Security benefits, the annuity will equal a specified percentage of the employee’s final average compensation, much like a traditional defined benefit pension plan.
A defined contribution SERP provides periodic contributions to an individual employee account. The money remains invested for the employee until retirement, death, or a disability triggers payment.