How a retirement plan option can keep executives accountable for life
In recent years, many supplemental executive retirement plans (SERPs) have been initiated, and others re-tooled, to provide important, shareholder-friendly executive retirement benefits. They have long been used by companies in nearly all major industries, including high technology. In a recent survey of non-qualified plans completed by Newport Group, 30% of respondents report offering SERPs.
As a non-qualified retirement benefit, SERPs have always been subject to a substantial risk of forfeiture in the event that the company was to face severe financial difficulties, even bankruptcy. Since executives would become unsecured creditors of the company for the full promised benefits, SERPs provide an important incentive for executives to manage the company well for the long-term.
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Because this risk of loss continues while executives are being paid in retirement, non-qualified plans help ensure that executives do their best to select and train their successors and avoid reckless behavior.
For several reasons, SERPs are often very positive to shareholders:
- Incentive to meet corporate goals. SERPs can be structured so that they are paid only when certain corporate goals are met. Discretionary or performance-tied contributions can be made to the executive’s account based on financial performance targets, e.g., 25% of salary if the executive’s division achieves profitability that exceeds a pre-established threshold. Additionally, SERPs can be structured to require a payout over several years as opposed to a lump sum, further tying executives to the long term success of the company.
- Help to retain valuable executives. Because the vesting provisions for SERPs can be designed to occur over many years, executives, in effect, have a golden handcuff to stay with the company.
- Greater financial stability. Many executives are looking for some diversity from having so much compensation tied up in company stock, the value of which can fluctuate significantly. With SERPs, executives and companies can use a fixed-rate or variable-rate approach. With a fixed-rate, the underlying account value appreciates at a predetermined fixed-rate of return. A variable-rate approach allows executives to select equity and/or fixed income assets to determine the underlying return of the account.
- Financed efficiently for shareholders. SERPs can be structured so that they have a similar financial impact as cash incentives, stock awards and other forms of non-qualified benefits. The awards to executives can be informally financed through long-term vehicles such as corporate owned life insurance (COLI) that can even contribute to earnings and shareholder value.
- Greater amount of benefits. Because the SERP account benefits can grow on a tax-deferred basis, the payment that the executive will receive is substantially more than would be received by paying current tax and then investing on an after-tax basis. Upon retirement, the payments to the executive are taxed as ordinary income and are deductible to the employer in the year they are paid.
- Favorable proxy language. Too often companies’ proxy statements do not make clear that executives’ can lose SERPS or that the programs are tied to meeting corporate goals. In proxies’ highly scrutinized executive compensation section, the discussion about SERPs can often show how companies are acting in a shareholder friendly manner.
Below is some language that is often appropriate for companies’ plans:
“The SERP is an ‘unfunded’ plan. It is considered a general contractual obligation of the company and is subject to the company’s creditors. In the event that the company becomes insolvent, the participants will be unsecured general creditors of the company. This status with respect to these benefits aligns the interests of the participants with the long-term interests of the company and its shareholders.”
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For these and many reasons, SERPs can provide important, shareholder-friendly benefits. As such, SERPS should be an increasingly important and a preferred executive compensation vehicle in the years ahead.