Here’s All You Need to Know About the Supplemental Executive Retirement Plan (SERP)

Benefits are always a good thing, no matter what form they take or to whom they are offered. Imagine you are buying a house and the seller throws in the furniture. That is a pleasant surprise. Or think about joining a new company. While you get the basics like health insurance, life insurance, and maybe even stocks, you also discover that your employer offers a Supplemental Executive Retirement Plan. That is not just good news, that is really good news!

Supplemental Executive Retirement Plans (SERPs) are benefits designed for a select group of employees. Not everyone qualifies, and that is what makes them special. If you are eligible for one, it usually means you are already doing quite well in your career.

If your employer has offered you a SERP or you expect one in the future, it is important to know exactly what you are getting. So, let’s break it down in simple terms and start with the basics – what is a SERP retirement plan?

What is a SERP retirement plan?

A supplemental executive retirement plan is an additional compensation offered by an employer to a select group of employees. It is usually part of a long-term benefits package. Companies use SERPs to retain top talent and reward key individuals who play an important role in the organization’s growth and success.

Unlike standard retirement plans available to most employees, SERPs are selectively offered to only a handful. The value of a SERP varies by company and is often based on a percentage of your average compensation over a specific period, typically the last three years of your salary.

Supplemental executive retirement plans are most commonly offered to senior executives, but C-suite leaders are not the only ones who may qualify. Employers can extend SERP benefits to other high-performing or long-tenured employees. People with specialized skills or many years of experience at the company usually qualify for a SERP. So, if you are considered important to the business and have something special to offer, you may be eligible even if you are not at the very top.

A company can pay for a supplemental executive retirement plan directly through its cash flow. Some companies also fund it by purchasing a life insurance policy on the employee.

When you retire and become eligible to receive your SERP benefits, payouts are typically structured in one of two ways. You may receive the amount as a lump sum, or the company may pay it out as monthly distributions, similar to a pension. The payout structure is usually defined in the plan document, so you would know which of the two applies to you.

It is also important to know that SERPs are often tied to performance and tenure. Your previous performance reviews can affect both the value of your SERP and your eligibility to collect it. So, you would want to keep an eye on your metrics if you are looking to get a SERP in the future. These same benchmarks would also be considered to determine whether you can fully cash out your SERP when you retire.

Many employees also negotiate for a SERP, even if the company does not offer it directly. For example, if you think you are an important employee for your organization, you can negotiate for a SERP. Employees usually do this when they are looking for a hike or an incentive. Or, if they are thinking about switching companies. Companies may be willing to negotiate for a SERP to retain key employees.

Key things to note about a supplemental executive retirement plan and how it works

A SERP is based on a formal agreement between you and your employer. This agreement clearly states that the company promises to pay you a specified amount of supplemental retirement income, provided you meet specific eligibility conditions. These conditions could be related to how long you stay with the company, your role, your performance metrics, or your retirement.

Unlike traditional retirement plans, a SERP is fully funded by the company. Your employer typically pays for it using its current cash flow or by purchasing a cash-value life insurance policy on your life, as mentioned above. You do not contribute your own money to the plan.

This is one of the biggest distinctions between a typical retirement plan, such as a 401(k), and a SERP. You do not contribute your own money to a SERP. Only the employer would contribute to it. On the other hand, while you may receive employer matches, you would be the one to contribute to a 401(k) primarily.

However, just like a traditional 401(k), both the money in a supplemental executive retirement plan and the taxes on it are deferred while you are working. You do not pay tax on the benefit as it grows. Taxes are levied only when you actually receive the money. Once you retire and meet all the eligibility requirements, the company begins paying you the promised supplemental income. This may be paid as a lump sum or as periodic payments, depending on the plan’s structure. At that point, the money you receive is taxed as ordinary income.

It is important to note that you will owe both state and federal income taxes on this pension. The company, however, usually gets a tax deduction when it pays out the SERP benefits to you. But they get this only when the pension is paid and not while the benefit is being built up.

Here’s something extremely important you need to know about supplemental executive retirement planning:

If the SERP is funded using a life insurance policy, the company would own the policy, and not you. So, if you leave the company before you retire or meet the eligibility conditions, your employer will retain control over the policy and access to its cash value. This basically comes down to the fact that if you quit before the conditions state, you may lose the SERP benefit altogether.

Now, employees do not always quit a company willingly. There are a number of things that can go unplanned, including the most dreaded of situations, such as the death of an employee. In the unfortunate event of an employee’s death, the company is typically named as the beneficiary of the insurance policy. This allows the employer to receive the payout and any associated tax benefits. However, in some cases, the plan may give the lump sum or regular payouts to the employee’s loved ones, too.

Supplemental executive retirement plans – Benefits

When it comes to benefits, SERPs offer advantages for both employers and employees. Let’s find out what these are:

• Benefits for employers

SERPs are a great way to retain talent. These plans are designed to encourage employees to stay with the company for the long term. Since benefits are usually offered to tenured employees, one is not likely to walk away sooner. They are an incentive for senior executives to stick around.

SERPs also help companies attract top talent. Offering a supplemental executive retirement plan can make a compensation package far more appealing to experienced executives who have already maxed out traditional retirement options.

If the SERP is funded using a cash-value life insurance policy, the company does not lose out on the money either. Even if the employee quits, the plan is in the company’s name, not the employee’s. This helps recover costs.

Another important thing to note is that SERPs are non-qualified plans. This makes it easier for companies to set them up.

• Benefits for employees

The fact that these plans are non-qualified can also be an advantage for employees. For you, the absence of Internal Revenue Service (IRS) involvement ensures greater room for customization. The plan is not boxed into rigid IRS rules, and employers have greater flexibility to negotiate terms that work in your favour, especially if you are discussing a SERP as part of a compensation package.

For you as an employee, the most obvious benefit is also the money. You get extra retirement income. This income is given to you over and above the limits imposed by traditional plans like 401(k)s or pensions. There are also no contribution limits. Unlike 401(k) plans, which cap how much your annual contribution can be, SERPs allow you to create a potentially bigger retirement corpus.

SERPs are also tax-friendly in the short term. They offer deferred compensation, so you do not pay taxes while the benefit is accumulating. Taxes are typically due only when you start receiving payments, which may happen at a time when your income could be lower.

Some SERPs may also include death benefits. In such cases, the plan may provide a lump sum or continued payments to your family if you pass away prematurely. However, note that not all SERPs offer this feature. So, you must confirm this with your employer.

Supplemental executive retirement plans – Concerns

Just like the benefits affect both employers and employees, the drawbacks can also be concerning for both. Let’s find out more about the disadvantages and risks associated with these plans:

• Concerns for employers

Businesses that contribute to SERPs receive some tax benefits, but these are granted to companies right away. Unlike qualified retirement plans, the business receives a tax deduction only when SERP benefits are actually paid out. So, the company’s cash flow could still be impacted.

Another important risk is that SERPs are considered company assets. If the company runs into financial trouble or owes money to creditors, SERP assets can be seized. This is very different from 401(k) plans, which are generally protected even if a company shuts down.

• Concerns for employees

As an employee, the biggest risk you face is that SERPs are not guaranteed. Your benefit depends heavily on the company’s financial health. If the company files for bankruptcy or creditors come after its assets, you could lose some or all of what you were expecting to receive in retirement.

SERPs also come with strict conditions. If you do not abide by these, you stand to lose your benefit. For instance, you need to be working at the same company for a minimum number of years. If you leave early, you lose the benefit entirely. Vesting schedules are meant to encourage you to remain with the company, but they can be quite the pain if, at the end of the day, you do not qualify for the benefit. Some companies offer SERPs tied to performance. In this case, if you do not perform well, you could lose your eligibility.

Another factor to keep in mind is that your future payout may depend on the company’s performance. In some cases, if the company performs poorly, your SERP’s funding can be affected. Ultimately, you will receive a lower payout.

So, should you negotiate for a supplemental executive retirement plan after all?

In most cases, yes, you should. A SERP is still an asset, and if you are in a position to negotiate for one, you really do not have much to lose by asking. However, it is important to keep your expectations grounded. A SERP should never be your only retirement plan. You can’t afford to ignore your 401(k), Individual Retirement Accounts (IRAs), or other long-term investments just because a SERP is on the table. Having one is great, but it cannot and should not replace the need for a diversified and reliable retirement income stream.

The reality is that a SERP comes with conditions. If things do not go as planned, you may not receive the benefit at all. That is why it is best viewed precisely as the name suggests – supplemental. When you combine it with traditional retirement accounts and other investments, it can be a good addition. But if you look at it on its own, it may simply not be enough.

In short, negotiate for it if you can, and be happy if you get it. But do not rely on it alone. Speak to a financial advisor and build your retirement plan on a well-diversified foundation. You may explore our financial advisor directory to look for an advisor with expertise in supplemental executive retirement planning.

Frequently Asked Questions (FAQs) about supplemental executive retirement plans

1. What is the SERP retirement plan?

A SERP, or Supplemental Executive Retirement Plan, is an additional retirement benefit offered by an employer to select senior employees, usually top executives. It is normally given to people who have been with the company for several years and have a strong performance track record.

2. Do you automatically qualify for a SERP if you have been with the company for many years and perform well?

No, you do not. Even if you have been with the same company for 10 years and consistently perform well, a SERP is not guaranteed. However, your experience and performance can put you in a position to negotiate for one.

3. Are SERPs guaranteed for all senior executives?

No. SERPs are offered entirely at the company’s discretion. Even among high-level executives, not everyone receives one. The company decides who qualifies for the benefit. The company also has final say on how much the benefit will be and under what conditions it will be paid out to the employee. Employees can, however, negotiate for better terms.

4. Why do companies offer SERPs?

Employers offer SERPs mainly to attract and retain top talent. SERPs enable employers to attract high-income employees who may easily surpass the contribution limits of traditional retirement plans like 401(k)s.

For additional information on retirement planning strategies tailored to your specific financial needs and goals, please visit Dash Investments or email me directly at dash@dashinvestments.com.

About Dash Investments

Dash Investments is privately owned by Jonathan Dash and is an independent investment advisory firm that manages private client accounts for individuals and families across America. As a Registered Investment Advisor (RIA) firm with the SEC, they are fiduciaries who put clients’ interests ahead of everything else.

Dash Investments offers a full range of investment advisory and financial services tailored to each client’s unique needs, providing institutional-caliber money management services based on a solid, proven research approach. Additionally, each client receives comprehensive financial planning to ensure they are moving toward their financial goals.

CEO & Chief Investment Officer Jonathan Dash has been profiled by The Wall Street Journal, Barron’s, and CNBC as a leader in the investment industry with a track record of creating value for his firm’s clients.