Nonqualified May Be Better than It Sounds
A valuable employee is a great thing and losing them could be devastating. A high salary along with the standard benefits package may not be enough to keep a key person in a vital position. A SERP is one innovative way to offer an attractive fringe benefit to a select employee.
What Is a Qualified Retirement Plan?
Qualified retirement plans are created by an employer to provide retirement income to employees and their beneficiaries. Such “qualified” programs are federally approved, can have huge tax advantages, and may allow for employee and/or employer contributions. Since these plans fall under the Employee Retirement Income Security Act of 1974 (ERISA), employers are forced to follow certain procedures to ensure fairness in accessing such programs.
Some common qualified retirement plans are as follows:
- 401(K) plan
- Pension plan
- Profit sharing plan
- Employee stock ownership (ESOP) plans
- Money purchase plans
Administering these plans involves strict reporting requirements. Regulations specifically prevent discrimination in favor of highly compensated employees.
Innovation Using a Nonqualified Plan
Nonqualified plans are not federally regulated which means employers are free to structure a program for certain employees with minimal Department of Labor reporting required. These plans do not enjoy the tax advantages that qualified plans do, but offering a nonqualified plan tailored to a key employee can often go a long way in keeping him/her from leaving for another opportunity.
Offering a Supplemental Executive Retirement Plan (SERP)
Qualified plans have unfavorable consequences to highly paid employees since government regulations restrict the amount they may contribute. A SERP helps evade the disadvantages of a qualified plan by “supplementing” it with an additional plan. The company draws up an agreement to pay a highly paid employee an annual retirement income. The obligation is funded by buying life insurance on the employee. The company pays all premiums and controls the cash value. When the employee retires payments are made from the cash value and/or company cash flow. When the employee dies, the company is positioned to recoup its costs from the policy. Depending how the document is written, the employee’s beneficiaries may share in the death benefits.
Golden Handcuffs Approach
SERPs are attractive to both employee and company in that the employer enjoys flexibility in contract structure, allowing for an agreement to specifically suit an employee’s needs. Since the intention of such a plan is to retain an employee, there will likely be a provision that no benefits will be distributed until said person reaches a certain retirement date. It is this “golden handcuff” feature that makes establishing a SERP so appealing to the employer. A financial advisor can provide guidance on how to structure a SERP that mutually benefits the company and that key employee.