Executive Benefits
Companies have long used non-qualified, supplemental retirement plans to help retain and attract quality executives. As many baby boomer executives approach retirement, and need to accumulate more funds to maintain their lifestyle, the need and appreciation for these benefits never has been greater.
Properly designed supplemental, non-qualified retirement plans can provide important incentives and rewards to executives, and also increase shareholder value. Below are some examples of different strategies.
Key Person Insurance
Many family businesses depend on non-family employees for the company's continued success. To guard against financial loss due to the absence of an indispensable key employee, many companies take out key person life insurance.
Non-Qualified Deferred Compensation
As a result, many executives will receive less than 20 percent of their final compensation in retirement income from company sponsored retirement plans. However, to maintain pre-retirement living standards, executives often need to receive 75 to 80 percent of their final compensation in annual retirement income.
To bridge this retirement planning gap, many companies employ non-qualified deferred compensation plans for executives who choose to defer more pay for retirement. Some companies also match a portion of executives’ contributions. These programs encourage higher compensated employees to take responsibility for their own retirement savings. Depending on the financial approach employed and related administrative matters, the tax benefits can include:- Income deferred is not subject to current income tax, improving earnings power by increasing total plan contributions.
- Earnings and investment appreciation on balances are not subject to current income tax.
- When the income is distributed and then taxed in retirement, the participant may have a lower tax rate.
- Accounts may be re-allocated to different investment alternatives without triggering current taxation.
Supplemental Employee Retirement Plans (SERPs)
Another trend today is the use of Account Balance SERPs. With these programs, discretionary or performance-tied contributions are made to the executive’s account, based on a financial performance target (e.g., 25% of salary if profitability exceeds a pre-established threshold).
With a SERP, the employer chooses who participates, the level of benefits, the types of benefits, and the plan provisions. The trade-off for flexibility is that the participants’ benefits are subject to the employer’s creditors.
A SERP usually is structured as follows. The employer and the employee enter into a contractual agreement where the employer will provide pre- and/or post-retirement benefits. This can be either a specified dollar amount or a benefit tied to a qualified pension plan, which is often called an “excess pension.” The employer accrues the retirement benefit expense.
Upon retirement, the employer pays a lump sum or series of annual retirement benefit payments to the employee. This is taxed as ordinary income to the executive in the year it is received and is deductible to the employer in the year it is paid. If the executive dies before retirement, the employer pays the spouse or other surviving beneficiaries. The payout is similarly taxed as ordinary income to the employee’s heirs in the year it is received and remains deductible to the employer in the year or years in which it is paid.
