Supplemental Executive Retirement Plan (SERP)

Supplemental Executive Retirement Plan (SERP) – is a non-qualified Employer Funded Deferred Compensation Plan that is used to attract, incentivize, and retain key employees. Typically using a permanent life insurance policy as a funding mechanism, it is often used where a business does not have a qualified plan but may also be used to supplement existing qualified plans in order to provide additional retirement distribution benefits to key employees, and/or provide death benefits to the key employee’s family.

The business and the employee typically enter into a written “SERP” agreement in accordance with IRC section 409(A). One of the main differences between a SERP and an Executive Bonus Arrangement (EBA) is that in a SERP it is the business that typically owns a permanent life insurance policy on the employee where as in an EBA it is the employee that retains personal ownership of the policy, albeit in accordance with the rules within its written agreement.

The advantages of a SERP include the ability of the company to fund retirement benefits to the key employee and/or death benefits to his/her beneficiaries. This is typically done by withdrawing cash value from the policy up to the policy’s basis, with additional withdrawals potentially available through loans against the policy’s cash value. The benefit to the employer is typically created within the SERP agreement by including a requirement that the Key employee remain with the business until his/her retirement in order to receive such benefits. If the employee decides to leave early, he/she will potentially forfeit all or part of the monies as set forth in the SERP agreement. One should also note that a disadvantage of the SERP is that the plan is subject to any claims of the company’s creditors.

At the death of the Key employee, the employer will generally receive a death benefit from the insurance policy which will reimburse it for the original premiums it made to fund the SERP agreement. The amount paid to the employer will typically be net of any loans plus accrued interest that were withdrawn from the policy’s cash value to fund any retirement distributions that were made beyond the basis in the policy.

An additional point to note is that when retirement benefits are paid to the Key employee, or when benefits are paid to the key employee’s beneficiaries, the business can deduct these payments from their income tax as compensation paid to the employee. Likewise, retirement benefits paid to the employee or benefits paid to the employee’s family at death would be considered taxable income to them.