What Is a Supplemental Executive Retirement Plan?

LAST REVIEWED Jul 23 2020 9 MIN READ

By The Human Interest Team

Employee benefits are a huge factor when it comes to attracting and retaining top talent for leadership positions in a company. Employers can boost the allure of their benefits package through a combination of paid time off, health insurance, and retirement contributions. A Supplemental Executive Retirement Plan is one popular way for businesses to recruit top executives by offering a lucrative long-term benefit.

What Is a Supplemental Executive Retirement Plan?

A supplemental executive retirement plan (SERP) is a type of retirement plan that companies offer select employees in addition to other retirement benefits. As a deferred compensation agreement, supplemental executive retirement plans give top employees an additional benefit to look forward to after they retire. An employer and an executive employee will agree to certain eligibility requirements and vesting conditions that allow that executive to have a larger nest egg with fewer limits than a 401(k).

Qualified vs. Non-Qualified Plans

There are two main categories of employer-sponsored retirement plans: qualified and non-qualified. Qualified retirement plans are eligible for certain tax breaks by meeting specific IRS requirements. The IRS tests and monitors qualified plans to ensure that everyone contributes a fair amount. Non-qualified plans, on the other hand, have no contribution limits and do not have testing requirements. Because they don’t follow IRS rules, non-qualified plans don’t get the same tax breaks as qualified plans like 401(k)s.

A supplemental executive retirement plan is a non-qualified plan. Employer contributions to a SERP are usually not tax-deductible, and the employee benefiting from the plan will not be eligible for many tax benefits until they start to receive distribution payments when they retire.

Who Gets Supplemental Executive Retirement Plans?

Companies usually offer SERPs to executive-level employees and other people who have highly sought-after skills. Because businesses don’t get tax breaks on non-qualified retirement plans, they usually limit the extra expense of SERPs to people who bring in a large amount of value to the company. While all employees create value through their work, executive-level positions are harder to fill and often require a large amount of hands-on institutional knowledge that they can only gain through on-the-job experience with a company.

SERPs are also popular perks for executives because of IRS restrictions on high-earning employees. Employees who make more than $125,000 annually or own more than 5% of a company can be ineligible for the standard benefits of a qualified supplemental executive retirement plan. SERPs allow high-earning employees to contribute as much as they want to a retirement plan, creating the potential for a high return on their investment at retirement.

Why Do Employers Offer SERPs?

Because the IRS has rules about how much highly compensated employees can contribute to their 401(k), some companies offer additional non-qualified retirement plans to their top executives. This can be an attractive benefit for top talent, and many companies use the long-term nature of SERPs to make their benefits package more competitive to increase employee retention throughout the years. Compared to qualified plans that companies must offer any employee who meets a few basic standards, business owners can offer supplemental executive retirement plans selectively.

Companies invest a lot of resources into managers, executives, and other high-level employees, so finding ways to increase employee commitment can help them save on the training costs associated with turnover while accomplishing goals in the long term. Executives often oversee department restructuring and other complicated initiatives that take place over several years, making them integral to how the company functions. Perks, like a supplemental executive retirement plan, can encourage an executive who is a key part of the company to make a long-term commitment.

SERPs have minimal reporting requirements and don’t involve IRS approval, so companies can design and manage plans based on their needs and what they want to offer their employees. Because the company owns its own policy, it can record income in its books based on the cash value growth of employee plans. Once it pays out the benefits when an employee retires, that company can then deduct that amount as a business expense. For qualified plans, business owners or corporations must pay taxes immediately.

How Do Companies Fund SERPS?

Companies pay for SERPs by budgeting out of their current cash flow or taking out a cash-value life insurance policy on the employee. As funds accumulate in the policy, the business can benefit from tax deferrals. In the long run, many companies are able to recover the cost of their SERPs by adjusting the structure of the policy to their needs. 

Using a cash value life insurance policy is the most common way for companies to pay for SERPs because it benefits both the employer and the employee. Executives can avoid immediate tax consequences and have peace of mind knowing that their family will get payments in the event that they pass away, while employers have a simple way to provide a long-term benefit to top execs.

How Do Supplemental Executive Retirement Plans Work?

Employers and executives can bargain to decide the exact terms of the SERP, including the amount the executive will receive in additional retirement information and their eligibility requirements. Next, the company will determine how to secure funds for the plan. Both the money in the account and the related taxes are deferred until retirement. When the employee retires, they will pay taxes on the money they withdraw as if it were regular income.

What Are the Risks of SERPs?

In addition to the non-exempt supplemental retirement plan tax treatment, SERPs come with some risks for both employers and employees. If a company owes a debt to a creditor, any SERPs can be subject to seizure. 401(k)s have a guaranteed payout even if a company shuts down, while SERPs require planning on behalf of the company to secure its SERP assets. Employees can also lose their SERPs if they leave the company early, violate the terms of the agreement by failing to meet performance goals, or violate the agreement in any other way.

Talented professionals may be more likely to stay with their current employer if they have a great long-term retirement plan tied to that employer. 

Human Interest specializes in managing 401(k)s and other plans. Reach out to us and learn about how our comprehensive retirement plan services can help streamline benefits for your small- or medium-sized business.

We believe that everyone deserves access to a secure financial future, which is why we make it easy to provide a 401(k) to your employees. Human Interest offers a low-cost 401(k) with automated administration, built-in investment advising, and integration with leading payroll providers.

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