A Supplemental Executive Retirement Plan (SERP) is a means by which a business can provide a select employee—typically, a key executive—with additional (supplemental) retirement benefits.
These plans are commonly offered to attract and retain key business employees. A business sets aside resources to pay Supplemental Executive Retirement Plan (SERP) benefits to the participating executive. The employer can use several different types of vehicles to hold these assets and the employee who participates in the plan has no rights to those assets used to informally fund the benefits of the plan until they have reached a preset time frame.
When benefits are informally funded by the employer using insurance, the employer agrees to provide the participant with supplemental retirement benefits, survivor benefits, and, sometimes, disability benefits paid from its assets. Upon the death of the participant and the payment of the policy’s proceeds to the employer, the employer typically recovers its plan costs.
A Supplemental Executive Retirement Plan is a nonqualified retirement plan. Nonqualified plans offer the sponsoring employer no income tax deduction for contributions to the plan, but they do permit the employer to tailor the plan to meet its particular objectives and they can be tax deductible to the business when they are paid to the employee in the future. Because of the flexibility of such plans, an employer may offer participation to a single employee without having to include other employees. Or, it may offer one level of benefits under the plan to one employee and a different level of benefits to another. This type of “discrimination” is not allowed under qualified plans but is characteristic of nonqualified plans such as SERPs.
Although no tax deduction is given to the employer for contributions to a SERP, the long-term benefits enjoyed by the employer are likely to be substantially greater than the forgone tax-deduction. When benefits are paid to the plan participant, the amounts paid—amounts that are usually much larger in the aggregate than the total contributions—are then tax-deductible to the employer as business expenses. Furthermore, the employer may structure the plan to recover its plan costs.
Sometimes SERPs are referred to as “golden handcuffs” because the participating employee’s promised benefits may be forfeited if he or she leaves the employer’s service before retirement or before a period of time specified in the Supplemental Executive Retirement Plan agreement. Thus, the SERP acts as a restraint, inhibiting the participant from leaving the employer before retirement or the period recited in the agreement.
Supplemental executive retirement plans offer substantial benefits to both employers that establish them and to the employees chosen to be plan participants. Despite those significant benefits, SERPs are not appropriate in all situations.
For a SERP to be suitable, the employer must be able to continue in existence beyond the retirement of the plan participant. In addition, even if the employer can be expected to outlive the participant, a SERP is generally unsuitable as a benefit plan for the following:
- a 5 percent or greater owner of an S corporation
- a sole proprietor
- a controlling shareholder of a regular corporation