Advantages and Disadvantages of Supplemental Executive Retirement Plans (SERPs)

What is Supplemental Executive Retirement Plan (SERP)?

A Supplemental Executive Retirement Plan (SERP) is a non-qualified deferred compensation arrangement designed to provide additional retirement benefits to select executives beyond what standard qualified plans offer. It helps bridge the gap between typical retirement income and the higher earnings of C-suite executives, enhancing retention and rewarding performance.

Unlike qualified plans, SERPs are tailored individually and create a specific obligation for the employer to pay benefits upon retirement or separation.

Key Characteristics

SERPs have distinct features that differentiate them from traditional retirement plans:

• Non-qualified plan: They are exempt from many qualified plan rules, allowing selective participation of key executives.
• Customizable benefits: Employers can design benefits based on tenure, performance, or compensation to align with company goals.
• Company liability: SERPs represent a future obligation on the employer’s books, often requiring precise accounting like a T-account to track.
• Tax deferral: Contributions and earnings grow tax-deferred until distributions begin, typically at retirement.
• Selective participation: Only top executives typically participate, unlike qualified plans that cover all employees.

How It Works

SERPs function by promising additional retirement payouts which are either funded or unfunded by the employer. These plans often use corporate-owned life insurance or other financial instruments to fund the future payouts, but funding is not always mandatory, impacting the plan’s security.

When the executive retires or leaves the company, the promised benefits are paid out, supplementing income from qualified plans. This structure is especially valuable for baby boomer executives who seek to maintain their pre-retirement lifestyle beyond standard pension limits.

Examples and Use Cases

Many large corporations utilize SERPs to retain and reward their senior leaders:

• Airlines: Delta and American Airlines have historically used SERPs to retain key executives amid industry volatility.
• Technology firms: Tech companies often supplement equity compensation with SERPs to provide stable retirement income.
• Financial sector: Banks and financial institutions use SERPs to align executive compensation with long-term performance metrics.

Important Considerations

While SERPs offer significant benefits, they also carry risks such as increased employer liability and administrative complexity. Since they are non-qualified, there is less regulatory protection, meaning executives’ benefits could be at risk if the company faces financial distress.

Understanding the plan’s terms and ensuring compliance with relevant tax rules and reporting requirements is critical. You may want to explore related concepts like deferred acquisition costs to fully grasp the accounting implications.