You’ve seen the acronym SERP, but what exactly are these retirement plans, and how do they differ from other retirement benefits? 

A supplemental executive retirement plan (SERP) is one way businesses can reward and retain key employees. Here are the top three things you need to know about these plans as a small business

SERPs are intended for highly compensated employees

This type of retirement offering is included in a broader benefits package to attract and retain high-level executives at a company, particularly C-suite employees. It’s an incentive that can make a business more competitive in attracting top-tier talent.  

These are the basics: The company and the executive enter into an agreement. The company promises to pay supplemental retirement income, and the executive commits to meet the eligibility requirements set forth in the agreement (such as remaining with the company for a specified amount of time). Company performance may be tied to the agreement, as well. 

Usually, the plan represents a percentage of an employee’s three-year average compensation and is funded out of cash flow or using a cash-value life insurance policy, a type of permanent life insurance that is purchased on the key employee’s life. 

A SERP is a non-qualified deferred compensation plan

A SERP has several fundamental differences from qualified retirement plans, such as a 401(k). As non-qualified plans, the funds aren’t subject to the 10% tax penalty for withdrawals before age 59 ½, and there are no required minimum distributions after age 70 ½.  

The fact that they’re non-qualified also means that companies don’t need to offer the plans to all employees, just to highly compensated employees (HCEs) or other executives that would be difficult to replace. They also aren’t subject to approval by the IRS or annual contribution limits. This fact makes them a great tool for saving for retirement above and beyond the contribution limits of an IRA or 401(k), which are met quickly by high-salaried employees.  

They are tax-deferred, meaning that the funds grow without taxation.  Withdrawals are taxed as regular income as soon as the executive starts making withdrawals. The company doesn’t receive an immediate tax deduction when funding an SERP, but the company can deduct funds as a business expense when they are paid. 

A SERP has several advantages for businesses

In addition to providing a way to attract and retain high-caliber executives, SERPs offer a number of benefits to businesses. They’re fairly easy to implement and administer and require no IRS approval. Businesses have the leeway to determine who it would like to reward with these benefits. 

If a cash-value life insurance policy is used, the company controls the plan, pays the premiums, owns the policy, and is the plan beneficiary. The funds in the policy grow tax-deferred and can be used at the company’s discretion. If the employee dies, the policy’s death benefit can be used to recover the cost of the plan and to provide benefits to the executive’s beneficiaries. 

There is one notable disadvantage for both the business and the executive, and that is that the funds accumulated are not protected from creditor claims in the event the company becomes insolvent. 

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