Supplemental Executive Retirement Plan - SERP
DEFINITION of 'Supplemental Executive Retirement Plan - SERP'
A supplemental executive retirement plan (SERP) is a nonqualified retirement plan for key company employees, such as executives, that provides benefits above and beyond those covered in other retirement plans such as IRA, 401(k) or nonqualified deferred compensation NQDC plans. There are many different kinds of SERPs available to companies wishing to ensure their key employees are able to maintain their current standards of living in retirement.
BREAKING DOWN 'Supplemental Executive Retirement Plan - SERP'
A SERP is a form of executive deferred compensation often used by corporations as a way to reward and retain key executives. Because SERPs are nonqualified, they may be offered selectively to high-earning executives whose qualified plan contributions are limited by top-heavy rules. The company and the executive enter into a formal agreement that promises the executive a certain amount of supplemental retirement income based on vesting and other eligibility conditions to be met by the executive. The company funds the plan out of current cash flows or through the funding of a cash value life insurance policy, and the deferred benefits are not currently taxable to the executive. Upon retirement, the executive receives the income, which is taxed as ordinary income.
Advantages of a SERP
SERPs are a viable option for companies seeking to maximize their key executive’s retirement income. They are nonqualified and require no IRS approval and minimal reporting. The company controls the plan and is able to book an annual expense equal to the present value of the stream of future benefit payments. When the benefits are paid, the company is able to deduct them as an expense. When a cash value life insurance policy is used to fund the benefits, the company benefits from tax deferred accumulation inside the policy. In most cases, the policy can be structured in a way that allows the company to recover its cost.
For executives, the plan can be tailored to meet their specific needs. The benefits accrue to the executive without any current tax consequence. When funded with a cash value life insurance policy, the death benefits are available to provide a continued supplemental payments or a lump sum payment to the executive’s beneficiaries in the event of a premature death.
Disadvantages of a SERP
When funding a SERP, the company does not receive an immediate tax deduction on any payments. The funds that accumulate for a SERP inside a life insurance policy are not protected from creditor claims against the company or company insolvency.