Optimizing Your Supplemental Executive Retirement Plan
As you review the company benefits available to you, is a SERP (Supplemental Executive Retirement Plan) on that list? When should you consider taking advantage of this savings option and how can it best serve you?
If you have maxed out the contribution to your profit sharing, 401(k), 403(b), 457 and other traditional, tax qualified retirement plans and you still want to put more of your compensation away, sheltered from income tax, a Supplemental Executive Retirement Plan (SERP) may be just what you need.
A SERP can look and feel a lot like a tax qualified retirement plan such as a 401(k) plan. Like a 401(k) plan, a SERP can be composed of company and/or participant contributions. These amounts can be invested in mutual funds where they grow and accumulate until they are distributed to the participant at retirement. While there are a lot of similarities with a 401(k) plan, a SERP is a completely different animal all together.
What’s the Difference?
One of the biggest differences between a 401(k) type plan and a SERP is that monies earmarked by a company to help fund its future obligations to the SERP participants are subject to the claims of the creditors of the company.
Generally the SERP participant has no more rights to these funds than those of an unsecured creditor of the company, even though these funds may have been deferred by the participant out of the compensation they could have otherwise taken home. ERISA regulations can protect money inside of a tax qualified retirement plan, like a 401(k), from company creditors. A SERP is not covered by ERISA and has no such protection.
Therefore the size and financial strength of the sponsoring company can weigh heavily on your decision about whether or not to save current income taxes by electing to defer some of your compensation into a SERP. The risk of forfeiture will also affect the second big difference between a 401(k) plan and the SERP: how and when the funds are distributed.
Many SERPs require the participant to annually decide when they want their next year’s contributions to be distributed. Their options can include immediately upon retirement or termination, or spread over five, 10, 15 or 20 years after retirement or termination. This election is generally binding and adds significant complication to the proper management of these funds.
If you are concerned about the stability of the company, you may want all your SERP paid out immediately upon retirement or termination. But this can cause an income spike and subject large amounts of your income to maximum income tax rates that could have been avoided if these payments were spread out over a term of years. You may want to spread these distributions over the maximum period, say 20 years, to keep the deferred tax growth working as long as possible. But this also stretches out your risk of forfeiture. A middle approach could be to choose a payout period that is expected to help you bridge between your expected retirement date (say age 65) and when required minimum distributions must begin from your tax qualified plans at age 70.5.
The point here is to be intentional about your distribution elections, and be consistent. If over 10 years of contributing to a SERP you make ten different distribution elections, you might be very surprised when the SERP begins to pay out in sporadic amounts.
Your distribution elections will directly affect how you choose to invest these funds. If you elect a more rapid distribution pattern, say over five years to bridge you from age 65 to age 70, you may want to invest the money in your SERP more conservatively as you approach age 65 so your money is there when you need it. You can still invest more aggressively with the other parts of your portfolio that will remain invested for longer periods of time.
What’s the Solution?
It helps to have a financial plan — one that contains a future wealth projection and considers when you expect to retire, what assets you plan to live on and how your SERP payouts will contribute to your financial future. That way, you can confidently plan how much to defer, choose your distribution pattern, and decide how to invest your money while it is in the plan.
A SERP can be a powerful financial tool, increasing the velocity of your money and providing significant cash flow in retirement. Remember, there are unique attributes and challenges that must be considered to help assure that a SERP contributes as it should for your financial future.
Tom Kirk is president, founder and WealthCoach at FirstWave Financial in Satellite Beach, Fla.