If you’ve ever lost a key employee to a competitor, you know first-hand how deep the pain is. Not only does the departure of a key employee hurt your bottom line, but you must spend valuable time finding and training a suitable replacement. If the executive was a possible successor to run your business in the future, you may have to consider other, less appealing options.
Key employees drive revenue and are important to perpetuating the business. But, in today’s economy, key employees are less loyal and might be tempted to leave for even slightly greener pastures.
One way your company can attract and retain top people is to reward them with additional compensation through a supplemental executive retirement plan (SERP).
Highly compensated employees are typically not able to put away enough for retirement through the company’s 401(k) and profit sharing plans. With a SERP, your company agrees to provide a benefit to an executive based upon satisfaction of terms and conditions that the company sets forth, such as sales goals, performance and longevity. You choose who participates, the level of benefits, the types of benefits, and the plan provisions. Benefits typically include retirement income, survivor benefits, and disability payments, and are subject to your company’s creditors.
Most businesses earmark assets and current cash flow to pay future SERP liabilities because the “pay when due” approach may put too much financial pressure on the business. Most organizations choose to informally fund SERPs with taxable investments, such as equities, or with tax-favored Corporate-Owned Life Insurance (COLI). Both offer attractive, growth-oriented investment opportunities.
Assuming the executive can medically qualify for the coverage, COLI can provide additional tax advantages: tax-free gains on investment earnings in the policy, tax-free access to cash values through policy withdrawals and loans, and an income tax-free death benefit at the passing of the executive.
The coverage can be even designed to allow your company to eventually recover all or a portion of the SERP costs, including benefit payments and policy premiums. A SERP could be established with a COLI policy on the executive’s life that is sufficient to provide the future benefits outlined in the agreement. The business would own the policy, pay the premiums, and serve as beneficiary.
At retirement, the executive would receive supplemental income benefit based upon the terms of the SERP agreement. The company would access policy cash values to provide the agreed-to benefit to the executive. The retirement benefit would be taxable to the executive and deductible to your company.
When the executive eventually passes away, the company receives the tax-free death benefit proceeds as a mechanism for cost recovery.
If the executive dies before retirement, the death benefits are paid income tax-free to the company. The business can then provide the benefits promised to the executive’s beneficiaries and use the excess funds to recover the cost of the plan and protect the business from the loss of the executive.
A properly designed SERP can be a valuable tool.