3 Reasons Why a Business Would Want to Establish a Supplemental Executive Retirement Plan

By September 10, 2018 Employee Benefits No Comments

The main reasons why a business would want to establish a Supplemental Executive Retirement Plan (SERP) are to meet the needs of both the business and the executive.

By establishing a Supplemental Executive Retirement Plan, the business will help the employer to attract and retain a key executive while, at the same time, it enhances the level of the executive’s retirement income. However, there may be reasons other than these that point a business owner toward a SERP, including using the SERP:

  • as a substitute for a qualified plan
  • to help ensure that successor family owners have an experienced management team or
  • as a substitute for an ownership stake in the organization

Let’s consider these reasons.

Establish a Supplemental Executive Retirement Plan as a Substitute for a Qualified Plan

Qualified plans enable the business to meet a range of objectives. However, they tend to be prohibitively expensive for some organizations and somewhat inflexible because of the need for the plan to meet ERISA requirements. Furthermore, some employers may feel little or no obligation to help provide for the retirement security of their rank-and-file employees, but do want to offer retirement benefits for some of their senior employees—particularly the business owners and the senior executives.

A SERP permits the employer to give selected employees extremely generous retirement benefits. Because no government approval is necessary (though Department of Labor notice may be required), these plans are almost always discriminatory and usually provide benefits for no more than a handful of senior executives. The possible adverse reaction from other employees who are not included in the plan is usually avoided because there is no requirement that the employer provide notice to these employees, and they frequently are unaware of the existence of these plans.

Establish a Supplemental Executive Retirement Plan to Ensure Successor Owners of an Experienced Management Team

Family businesses often remain in the family when the current owner steps down provided there is sufficient capital along with a family member interested in and capable of managing the business when that occurs. But, what happens when there are minor children who may eventually have an interest in working in the family business but who have years of education ahead of them before they plan to enter it?

The answer may lie in ensuring the continuation of an experienced management team to run the business during that interim period. An important question is how to ensure the management team’s continuation. Executives or managers deemed critical to the business’s success could be offered benefits under a SERP—say, a retirement benefit of 50 percent of their final salary for a period of 15 years—provided they remain with the business for 10 or 15 years. The payout date would be set to correspond to the time when a child or children will be ready to step into the business and take the reins. In this way, by establishing a Supplemental Executive Retirement Plan, the business can help ensure management continuation during a period of transition.

Establish a Supplemental Executive Retirement Plan as a Substitute for an Ownership Stake for a Key Employee

For many business executives, the opportunity to gain an equity position—to own some or all of the business, in other words—is much sought after. Conversely, owners of closely held corporations often choose to limit ownership to a very few individuals and, if stock shares are granted to others, to limit those shares to a small minority ownership. This tends to keep control of the entity in the hands of current owners.

Key executives, mindful of the decided lack of control granted by minority ownership, often see a minority interest in a close corporation as having little value. Normally stock shares in close corporations have restrictions on their sale. Furthermore, even without these typical restrictions, the market for minority interests in close corporations is normally so thinly traded that it is virtually nonexistent.

For this reason, many businesses establish a Supplemental Executive Retirement Plan as alternatives to granting a key executive an ownership interest in the company. The plan is completely selective and may meet both the financial and psychological needs of the executive.