If you are not offering a supplemental executive retirement plan (“SERP”) to your officers and executives, you likely have to answer “no” to the above. Since a SERP is designed to supplement other retirement benefits offered by an employer, such a plan can help an executive increase their income during retirement which may not be met by traditional retirement plans.
A SERP is a deferred compensation agreement between the company and key employees under which the employer will provide additional retirement benefits if the individual meets eligibility and vesting requirements. A SERP is funded by the employer from its general assets, investments, or the cash value of life insurance.
SERPs are not qualified plans, such as a 401(k), and are not subject to the same rules, which limit the amount of money that may contribute to a plan. There are no dollar limits on contributions to SERPs. This can allow eligible employees to accumulate much more in retirement savings than under just a traditional qualified plan. In addition, the rules for required minimum distributions and withdrawals before age 59 ½ do not apply to SERPs.
While SERPs have advantages, they can have risks. Most SERPs require individuals to meet certain conditions such as a length of service provision to receive payment. If the service requirement is not met, the individual will receive nothing under the SERP. In addition, most SERPs are funded based on company performance. If the company has a run of bad years, the SERP may not pay as much as expected.
SERPs can result in tax disadvantages for higher-income employees. Payments from SERPs are taxed at ordinary income levels when they are paid. Many expect to be in a lower tax bracket upon retirement, but this may not be true for all. The combination of state and federal taxes could erode more of the benefit than an executive may expect. However, even after taxes, the SERP participant would receive more income during retirement than if they had only a traditional 401(k) or similar plan.
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