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SERP Funding – Life, Disability and Critical Illness Insurance.

Kevin Wenke

Kevin Wenke

Owner at Decision Tree Financial. CFP. CLU

Using insurance such as cash value life insurance, disability insurance and even critical illness insurance can provide your key employee with the compensation they desire in order to stay with your firm.

A SERP is sometimes categorized as a deferred compensation plan. However, unlike a true deferred compensation plan under which a participant actually defers receipt of compensation, the participant in a SERP defers no compensation that he or she could have received in cash.

Instead, the employer will informally fund a SERP and promise the benefits in their entirety.

Although the benefits that can be offered under a SERP may vary considerably from one plan to another, it’s common to find that many SERPs offer participants three distinct benefits:

  • Retirement benefits
  • Disability benefits
  • Survivor benefits

The actual SERP design and its benefits usually depend on the objectives of the employer and the needs of the executive participating in it.

Funding SERP Retirement Benefits

While a SERP may provide participant retirement benefits at virtually any amount for any duration, many plans limit the amount and duration of payments to some percentage of income for 10 or 15 years.

For example, a SERP might provide retirement benefits equal to 50 percent of the executive’s final salary for a period of ten years. In any particular SERP, the annual benefits promised may be more or less than 50 percent of salary and may continue for a period that is longer or shorter than 10 years.

Furthermore, the plan benefits may be larger or payable longer for one key executive than for another.

An important byproduct of the SERP plan design is that, because the benefit is typically determined by the executive’s final salary, the actual benefit (at its commencement) tends to retain its purchasing power.

This is an important consideration because SERP agreements are often entered into many years before the participating executive’s retirement.

Since there may be many years until the employee receives their SERP benefits, using the cash value of permanent life insurance is a way to informally fund a SERP.

Funding SERP Disability Benefits

Although not included in all SERPs, many plans also provide for the payment of benefits in the event of the participant’s total disability.

Usually, the disability benefits are funded through an individual disability income policy owned by the employer, who is also the beneficiary for any disability benefits.

The money received by the employer from the insurance company can then be used to provide the executive with benefits without hurting the companies bottom line.

The disability income policy is usually conditionally renewable—the condition being the executive’s continued employment with the firm—and contains a non-transferability provision so that its benefits will not adversely affect the executive’s ability to be properly insured under a personally owned disability income policy protecting his or her earned income.

The benefits provided to the totally disabled executive under a SERP are generally stated in terms similar to the terms that describe his or her retirement benefits.

As a result, it is not unusual for the total disability benefits provided under a SERP to give the disabled executive 50 percent of his or her current salary for the duration of disability but not for more than 10 years.

Alternatively, the disability benefit may continue until the executive’s age 65 or other age recited in the plan document, at which time the plan’s retirement benefits would commence.

In addition, in the event the executive has a heart attach, stroke or cancer, some SERPs provide additional compensation to the executive to help them deal with their illness. This is where the plan can be funded with critical illness insurance.

Where in the past these illnesses usually meant death, many people are surviving their illnesses though they may have to make adjustments to their way of life.

Critical illness insurance, like disability insurance, can be owned by the company on the executives life and those benefits can be paid out to the executive if they become ill with a covered condition.

Funding SERP Survivor Benefits

Just as an executive may become disabled, he or she could die while employed by the employer. For that reason, survivor benefits are usually a part of a SERP. Survivor benefits under a SERP are often provided at the same level as they would be at retirement.

Thus, it is not unusual to find survivor benefits in a SERP that provide 50 percent of the executive’s salary at the time of his or her death if death occurs prior to retirement.

Regardless of the actual benefits provided under the plan, it is important to understand that because the plan is nonqualified, it can be tailored to meet the employer’s needs and those of the key executive.

These SERPs are almost infinitely variable.

The use of life and disability insurance policies insures that the company has the ability to pay the promised benefits to the employee regardless of when they start to claim them.

Insurances unique ability to create a lump sum of money out of smaller periodic premiums when a qualifying event occurs, such as a death or disability, as well as permanent life insurance’s tax deferred and potentially tax free accumulation feature makes using it an ideal vehicle to informally fund a SERP.

Do you want to find out more about SERPs? You can contact us by clicking here and we will be happy to discuss any questions you have.

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