It is important to understand what a SERP really is: a promise. It is a promise by the sponsoring company — your employer — to pay you a retirement benefit, usually over a specified number of years. In many cases, the SERP promises to pay a benefit amount to the executive over a 10-, 15- or 20-year period beginning at a specific age, such as 65. If the executive dies before receiving the full benefit amount, his or her heirs may receive a present value of the future benefit that would have been paid over time. As I said before, SERPs can be an amazing benefit.
However, you should not confuse a promise with a guarantee. While the company may promise to pay a benefit to the retired executive, the reality is the strength of the promise is measured by the financial strength of the company. In other words, if the company fails or goes out of business, the SERP benefit goes away. Additionally, the assets intended to fund the SERP benefits are typically not protected from creditors. So, if the company is on the losing end of a lawsuit, its ability to meet the obligation of the SERP could be impaired.
From an accounting perspective, a SERP is a liability. If the company plans well, the liability is offset by an asset on the balance sheet that will fund the payment of the liability in the future. Many times, this asset is an investment in a cash-value life insurance policy owned by the company on the life of the executive. This requires the management of the company to thoroughly review the performance and overall suitability of the policy for its intended use. A cash-value life insurance policy can be a very appropriate funding tool for a SERP, but it is not a “set it and forget it” investment. If the policy does not perform as planned, there is a real risk the company will not have the necessary financial resources to pay the benefit promised to the executive.
Therefore, if you are an executive who has the benefit of participating in a Supplemental Executive Retirement Plan, be sure you handle your financial planning with an eye on both the financial strength of the sponsoring company, and the health of the investment funding your benefit in retirement. SERPs are very rich benefits, but keep in mind the income you stand to receive in retirement is a promise, not a guarantee.
William G. Lako, Jr., CFP®, is an Executive in Residence at Kennesaw State University’s Coles College of Business and a principal at Henssler Financial. Mr. Lako is a CERTIFIED FINANCIAL PLANNER™ professional.