A SERP is typically comprised of two components: the Agreement between the Company and the Executive/Employee and the Funding for the plan.

The Agreement is a promise by the Company to the Executive (usually documented in a legal contract executed by the parties) whereby the Company promises to provide the participant a future award subject to the participant reaching certain performance milestones, usually determined by duration of employment.

Funding the agreement can be made from Company cash flows as the award vests to the participant, or more commonly, by creating a “sinking fund” into which contributions are made ratably over the period from onset of the agreement to the time of full vesting. In the case of ongoing funding, plan contributions are made either into investments or most commonly, into a cash-value life insurance policy (advantages discussed below).

In order for the SERP to be successful in retaining the Executive, there are two essential components to the strategy:

• The award must be meaningful.
• The goals (duration) must be reasonably attainable.

 The deferred benefits are not currently taxable to the Employee as income, and are taxed only at the time of payment to the Employee. At that time, the Company receives a full tax deduction for the amount of the payout.

 Payment of the promised benefit to the Employee can be paid as a lump sum, over a period of years (with some form of interest), or often as a “salary continuation” plan.

Why use Life Insurance to Fund the Plan?

 When using life insurance to fund a SERP, the Company purchases a life insurance policy on the life of the Executive, owned and funded by the Company. The use of a life insurance policy to fund a SERP is universally deemed the most appropriate strategy (by public and closely held corporations alike) due to its unique advantages:

• Growth of the cash value inside the life insurance policy is tax deferred.
• The policy death benefit provides an immediate source of funds to pay the Executive’s family an accelerated benefit in the event of the participant’s death.
• The cash value of the policy is the source of funds to pay the Employee their promised future benefit, and can be distributed from the policy on a tax-free basis.
• The policy is designed for the Company to fully recover its costs for the program, which is not available from any other funding mechanism.

Advantages of a SERP

To the Company:

• The Company can be discriminatory by including only those individuals they deem essential to the long-term value of the Company.
• When life insurance is used, the cash values grow tax-deferred inside the Plan and creates non-taxable book income for the Company.
• There are no IRS regulations on contribution limits, limitations on timing of benefits to the Executive, or expensive plan administration costs associated with Qualified Plans.
• The Plan is relatively easy to implement and administer.
• There are no rules as to vesting! These are determined by the Company to match the “exit runway” of the Company owners, and hence the plan serves as the ultimate Executive Retention tool.

To The Executive:

• A SERP is usually designed to meet the needs of both the Company (retention) and the Executive (retirement).
• In the event of premature death (and often structured for total disability as well), the plan will pay out agreed upon benefits to the Executive or surviving family.

Disadvantages of a SERP

 To the Company: The Company does not get a tax deduction for the contributions to the plan until they are paid out to the participants.

To the Executive: The cash value inside the SERP must be “subject to substantial risk of forfeiture,” and the Executive would become a general creditor of the Company in the event of insolvency.