Understanding SERPs and Its Employee Benefits
By Mike Martinez, CLU, ChFC, AEP, Director, Doeren Mayhew Insurance Group
It’s no secret that your employees are the most valuable resource in your company. In today’s fiercely competitive business environment, highly talented people are in demand. You probably have one or more highly talented and highly compensated employees in your organization. It would be safe to say they are probably on a competitor’s or customer’s radar screen as a potential hire. Employee benefits, like qualified retirement plans, are often not enough to hold on to your key folks. Especially if they are maxed out on their contributions and are looking for other tax-favored methods to supplement their retirement. Non-qualified deferred compensation plans, like a Supplemental Executive Retirement Plan (SERP), are attractive to employers because it offers them the flexibility to be selective in the amount of the benefits it wants to provide for each employee.
Recruit, Reward and Retain
WHAT IS A SERP?
A SERP is an employer-sponsored, non-qualified deferred compensation plan. It allows employers to select key, highly compensated employees with supplemental retirement benefits in addition to benefits from a qualified plan such as a pension, profit-sharing or 401(k) plan. The plan is financed with contributions from the employer only and in addition to any other contributions to other company qualified plans. The employee does not contribute to the plan. The SERP can also provide a survivor benefit that is paid to the employee’s heirs in the event of their death.
WHAT ARE THE MECHANICS?
The employer and the employee enter into an agreement that stipulates the employer will provide the employee a certain amount of money at retirement. If the employee dies prior to the retirement date, a survivor benefit will be paid to their heirs.
A SERP can be financed in a variety of ways. The employer could choose to informally fund the SERP right from the company coffers. However, if several of the employees in the plan retire around the same time, the company could find itself in a poor cash situation. Alternatively, they could also establish a sinking fund, use mutual funds or explore marketable securities. If mutual funds or marketable securities are used, the employer has to pay tax on the income earned each year. Another method to informally create the fund and fulfill the plan’s obligations is through the purchase of a high-cash value accumulation life insurance policy on the life of the valued employee. Unlike mutual funds and marketable securities, if a life insurance policy is used to informally fund the plan, it retains all the tax benefits of a life insurance policy. The employer is the owner and beneficiary. The employee does not pay any costs attributed to the policy.
At retirement, the valued employee will begin receiving the deferred compensation benefit from the employer. Benefits are predetermined and can be paid in a lump sum or in annual installments. The employer recovers its cost from the cash values in the policy. As for tax, the employee will pay ordinary income taxes on the benefits received and the employer takes an income tax deduction on the benefits paid. Upon death of the employee, the plan will terminate and the employer receives the death benefit from the life insurance policy to help recover its costs of providing the benefit.
A SERP can be utilized as a recruiting tool but also used to reward and retain your key employees. It is an excellent complement to existing qualified plans and is an effective method of supplementing retirement income.
For more information regarding SERPs, contact Doeren Mayhew Insurance Group today.