Here’s All You Need to Know About the Supplemental Executive Retirement Plan (SERP)
A company is made up of different employees. Some are fresher trainees, just starting out their careers, and some are high ranking officials with years and years of experience. Every company has a different set of regulations while dealing with different categories of employees, based on their qualifications, departments, time spent in the company, salary, etc. While all employees may get regular retirement accounts from their employer, some lucky ones also get additional perks, apart from the regular 401(k). These special benefits are offered in the form of supplemental executive retirement plans.
What are supplemental executive retirement plans?
Regular retirement plans like 401(k)s fall under supplemental retirement plans, while the extra benefits that are given to only a fraction of employees in a company are called supplemental ‘executive’ retirement plans or SERP. These executive plans are very different from regular retirement plans as you can withdraw these funds before you turn 59½ years old, without having to pay any additional taxes or penalties. You also don’t need to make required minimum distributions when you hit 70½, which means that you get to keep your savings intact and use them at a later stage in life. In technical terms, SERP is a non-qualified plan, and hence, falls outside the rules that other qualified retirement plans are bound by. SERP is often linked to the employee’s as well as the company’s performance and can, thus, vary. It also depends on the discretion of the employer to decide who qualifies for SERP.
What are the components of a supplemental executive retirement plan?
The extra perks of the supplemental executive retirement plans are typically offered along with life insurance, health insurance, as well as stock options, to only some employees of the company. The company determines the value of SERP, but it is usually linked to factors like the employee’s tenure, metrics of the employee, performance of the employee across the tenure, as well as other benchmarks.
In case the employee doesn’t perform up to the mark by the time of his/her retirement, the company may also refuse to let them cash out their SERP.
The employer generates the funds for SERP either through regular cash flow or via an insurance policy in the name of the employee. This policy can be cashed out at the time of the employee’s retirement. The funds can be cashed-out in either monthly disbursements or a one-time lump sum amount, as per the employee’s will.
Who is eligible for the supplemental executive retirement plan?
A company is in no way obligated to offer SERP to all employees. In most offices, the plan is generally offered to CEOs, CFOs, COOs, other C-suite employees and high-level ranking officials. It is also up to the company to offer these benefits to as many people as they want. There is no maximum or minimum limit. The tenure of the employee with the company plays a crucial role in the decision, but many times, high-ranking employees are able to secure an executive retirement plan through negotiations. There are also some Internal Revenue Services (IRS) rules that companies have to follow while selecting employees for SERP. Any employee who has a 5% or more stake in the company, or earns more than $120,000 annually is not eligible for SERP. These highly compensated employees usually receive other plans in place of SERP.
What are the benefits of a supplemental executive retirement plan?
A supplemental executive retirement plan is a tax-deferred plan with high returns. Employees are only taxed after they start withdrawing funds from SERP. In case an employee opts for monthly SERP distributions, each monthly installation is taxed separately. On the other hand, in case of a lump sum withdrawal, the entire amount is taxed in one go. In case employees hit the limit for their regular retirement plans sooner than estimated because of their high compensations, they can be offered SERP as an additional plan to increase their savings for retirement.
What are the potential drawbacks of a supplemental executive retirement plan?
Since SERP is a non-qualified benefit that the company is not obligated to offer all employees, these plans have certain drawbacks as compared to regular retirement accounts. These funds are not protected in scenarios where the company is low on funds or goes bankrupt.
Supplemental executive retirement plans also come with some special rules of their own that may be unique to every company. For example, in order to avail the benefits of such a plan, an employee needs to work with the company for a specific tenure. The value of these plans is also linked to particular benchmarks that can change over the course of time. For instance, a well-performing employee may fall short of delivering quality work in the future. The employer has the authority to annul an employee’s SERP in such situations.
To sum it up
It may seem like a privilege to be offered the supplemental executive retirement plan as a high ranking official within a company but you must know that you still need to back it up with a traditional individual retirement account (IRA), Roth IRA, or a 401(k). When accepting SERP, you must always evaluate the future of the company, your future with the company, and other benchmarks carefully. Undoubtedly, SERPs have better benefits than regular retirement plans, but they are not mandatory or guaranteed. They are also very risky with market fluctuations and economic breakdowns. If your company is hit by the recession, chances are that your employer may annul all SERP accounts to save costs.
Do you have doubts about your company’s supplemental executive retirement plans? Reach out to financial advisors for advice on how to meet your retirement goals with SERP.