Small Business: Utilizing SERPs to Compete with Corporations

As mentioned in the previous article, two problems that smaller corporations face when competing with larger companies are hiring and retaining key employees, and inadequate retirement benefits offered to key employees and owners.  There is a common solution to this problem: A Selective Executive Retirement Plan (SERP).

SERP Benefits and Funding

A SERP is tailor-made with benefits to lure and keep certain key executives in the company.  Flexibility in choice of participants and benefits included is what makes a SERP the perfect vehicle for attracting and retaining key employees.  

A successful SERP is created with a promised benefit with a future liability.  Life insurance is a perfect vehicle to ensure that benefits will be paid. In addition, life insurance, owned by the company, allows for full recovery of all costs.

Summarizing a Selective Executive Retirement Plan Tax Results

The corporate tax benefits of providing a Selective Retirement Plan to key employees are important steps that can benefit a company.  Whereas premiums paid for life insurance bought to source a Selective Executive Retirement Plan are not tax deductible, the policy’s cash value converts to an important asset on the company’s balance sheet. Employer-owned life insurance proceeds obtained by the business at the death of the key employee are not commonly subject to the regular corporate federal income tax, if the following requirements are met for contracts agreed to after August 17, 2006.  

Beforehand, when the employer-owned life insurance contract is delivered, the key employee who is to be insured must be informed in writing that the employer plans to ensure the life of the employee.  The notice should include the maximum face amount that the employee’s life could be insured, along with stating that the policy owner, who is the employer, will be the beneficiary of the policy’s death proceeds.  

Additionally, the employee who is insured must furnish written consent to be covered or insured by the contract and to the same coverage continuing after the insured employee is no longer employed by the company.  In addition, the key employee insured must have been an employee of the company at any time during the 12-month period before the date of death or have been a director or highly-compensated employee at the time the contract was issued.

Since life insurance proceeds of this type may have corporate alternative minimum tax implications, it is advisable to consult a qualified professional tax advisor.  Benefit payments that are made to the executive or to the executive’s family are tax-deductible when paid if reasonable reparation requirements are met.

The tax benefits of a Selective Executive Retirement Plan may benefit a key employee who is participating in the plan.  Supposing the plan is appropriately structured, the key employee has no current income tax obligation. Benefits are taxed as regular income as received by the key employee or his/her family.  The current value of any survivor benefits payable after the key employee’s death will be incorporated in the deceased executive’s estate. However, an income tax deduction for any estate tax assigned to such additions.  Participating key employees should talk to their professional tax advisors regarding the impact of salary continuation payments on Social Security taxes and benefits.

Selective Executive Retirement Plans and Business Continuity

When the aim of an executive benefit plan is to allow a corporation to pay additional benefits on a discerning basis to key employees, including shareholder-employees, the continuity potential, the ability of the company to remain in business, of the corporation must be gaged, since the business must exist in order to pay the promised benefits as they become due.

Some questions that should be answered before a plan is put in place include:

  • Is the corporation likely to still exist at the owner’s death, disability or retirement?
  • Is it appropriate for assets bought by the corporation to fund future executive benefits to be available for payment to corporate creditors?

If the answer is NO to either of these questions, then a kind of selective executive benefit plan possessed by the employee may be a superior choice, such as:

  • Executive Bonus Plan – The corporation pays a bonus to certain key employees in the method of life insurance premiums.  The company removes its contributions, which are taxable to the employee. The key employee owns the policy, making it safe from corporate creditors, and can amass considerable cash values.
  • Collateral Assignment Split-Dollar Plan – In a split-dollar plan, the employer pays a portion of the cost, and the selected key employee is able to purchase cash value life insurance at a lessened cost to them.  With a collateral assignment split-dollar plan, the key employee owns the contract, making it secure from corporate creditors, and the employee then assigns the policy to the company as security for is premium contributions.

An Action Checklist Selective Executive Retirement

What to do now:  

  • Choose the key employee(s) to partake in the plan, along with the benefits and amounts.
  • Choose the applicable life insurance funding vehicle(s).
  • Fulfill the notice and consent requirements for employer-owned life insurance contracts.
  • Ascertain each key employee’s insurability.
  • Arrange for disbursement of premiums.

Short-Term:

  • Draw up and implement a Selective Executive Retirement Plan agreement and a corporate declaration approving the plan.
  • File a statement with the Department of Labor revealing the existence of the plan.
  • Evaluate the issued policy(ies), confirming that the company is the owner and beneficiary.

Long-Term:

  • A yearly review can help guarantee that the plan remains current.  
  • Gauge other employee benefit planning needs.
  • Assess key employee indemnification needs.

As with any complex business endeavor, a qualified tax professional is the best person to discuss all options.  A SERP is the best vehicle that a company can use to be competitive with mega-corporations. The allure of a SERP is the ability to recoup all of the business funds used to pay premiums and benefits to the employees.  Finding innovative ways to lure and keep highly-qualified professionals (such as Synergistic Life Services) who will grow your business is key to the profitability and longevity of a company.

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