Supplemental Executive Retirement Plans - Voya Financial · PDF fileSupplemental Executive...

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Transcript of Supplemental Executive Retirement Plans - Voya Financial · PDF fileSupplemental Executive...

Supplemental Executive Retirement Plans

Producer Guide

For agent/registered representative use only. Not for public distribution.

For agent/registered representative use only. Not for public distribution.2 3For agent/registered representative use only. Not for public distribution.

In todays labor market, it is important to recruit and retain top executive talent to ensure the growth and long-term success of a business. One way employers can do this is to offer a benefit that addresses a key concern of management and highly compensated executives retirement planning.

Employers turn to nonqualified deferred compensation plans as an executive benefit because of the dollar limitations that the Internal Revenue Code (I.R.C.) places on qualified plans. The Code limits the deferral amounts, and total plan contributions and also defines maximum allowable compensation.

In effect, the limits on contributions have made qualified plans reverse discriminatory. These plans fail to provide the same ratio of before-to-after retirement income for executives as they would for the average worker. Personal savings, Social Security and qualified plans may meet the retirement needs of many workers but more than likely will not be sufficient for todays highly compensated executives. Therefore, highly paid executives are actively seeking a means to replace lost retirement income.

Supplemental Exec utive Retirement Plans (SERPs) provide an attractive opportunity for rewarding valuable executives who need additional retirement income. Employer-funded SERPs are designed to reward executives who remain in the companys employment, devoting time and attention to building the profitability of the business. Not only do SERPs provide needed benefits to select executives, but they also allow the employer to maintain control. In this way, the employer, by imposing restrictions that can reduce or even cause the loss of benefits for the executive (golden handcuffs), is able to design a cost-effective method of rewarding and retaining valued executives.

Supplemental Executive Retirement Plans

For agent/registered representative use only. Not for public distribution.2 3For agent/registered representative use only. Not for public distribution.

In general, a SERP is a nonqualified plan financed by employer dollars that provides key executives with additional retirement income. The executive has no option to receive any employer contributions as current compensation. Nor does the executive defer any of his or her own funds toward the retirement obligation.

Because a SERP is financed with employer dollars, the plan is generally designed to favor the employer. The executives right to any benefits under the plan are normally restricted through the use of vesting schedules or documentation requiring a set period of service or employment until retirementthese restrictions are often known as golden handcuffs.

SERP benefits are typically calculated using a defined benefit approach formula. That is, the employer promises to pay to the executive a set amount at regular intervals for the remainder of the executives life or a designated number of years. This target amount is often determined by calculating the executives total retirement need and then reducing this projected amount by other sources of retirement income, such as Social Security benefits or other qualified plan benefits. These projections are usually based on the executives normal retirement age. If the SERP benefit begins earlier or later, the amount is adjusted accordingly.

A SERP is often informally funded with life insurance. The employer finances the benefit liability by purchasing life insurance policies on participating executives.

Supplemental Executive Retirement Plans withLifeInsurance

Heres how a SERP works:

1. The employer and the executive enter into a contractual agreement where the employer agrees to provide pre-and/or post-retirement benefits.

2. The employer purchases a life insurance policy on the executives life. The policy serves as an informal funding vehicle for the benefit liability.1

Employer Life Insurance Policy

SERP Agreement

Executive

2

1

Employer Life Insurance Policy

3

Executive

4Employer Life Insurance Policy

6

Executives Heirs or Estate

5

While executive is employed When executive retiresIf the executive dies prior to retirement

3. The employer pays the promised retirement benefit.

The payment is deductible by the employer (assuming compensation is reasonable).

The retirement benefit is taxable compensation to the executive.

4. With proper design, the benefits can be paid using income tax-free withdrawals from the informal funding vehicle, the life insurance policy.2 Income tax-free distributions are achieved by withdrawing to the cost basis (premiums paid) then using policy loans. Loans and withdrawals may generate an income tax liability, reduce available cash value and reduce the death benefit or cause the policy to lapse. This assumes the policy qualifies as life insurance and is not a modified endowment contract.3 Alternately, the company can pay the liability from current earnings and recover the cost of the plan upon receipt of the death benefit.

5. The policy pays an income tax-free death benefit to the employer.4

6. The employer pays any benefit owed to the executives heirs. This payment is deductible by the employer and is taxed as ordinary income to the heirs.5

1 As an informal funding vehicle, this policy remains available to the employers general creditors. A plan participant must have no rights in this policy if the promised benefits are to avoid current taxation.

2 Policy loans and partial withdrawals may vary by state, reduce available surrender value and death benefit or cause the policy to lapse. Generally, policy loans and partial withdrawals will not be income taxable if there is a withdrawal to the cost basis (usually premiums paid), followed by policy loans (but only if the policy qualifies as life insurance, is not a modified endowment contract and is not lapsed or surrendered).

3 If the policy lapses or is surrendered, the IRS will tax distributions received over the life of the policy and at termination that are in excess of total premiums paid.4 Death benefits from life insurance will be received income tax free if the policy purchase complies with the requirements of IRC Section 101( j), including the written

notice and consent provisions for the insured. May be subject to corporate alternative minimum tax (AMT).5 Compensation which was earned by the decedent but not included in his or her taxable income for the year of death is income in respect of a decedent (IRD).

1

For agent/registered representative use only. Not for public distribution.

5For agent/registered representative use only. Not for public distribution.

To Counter the Reverse Discrimination of Qualified Benefits I.R.C. 415(b) and 401(a)(17) act to limit benefits paid to highly compensated executives from qualified plans. Employers adopt SERPs to replace benefits lost to executives because of this reverse discrimination effect.

To Recruit New ExecutivesA properly designed SERP can be a deciding factor for an executive contemplating a career move. Most qualified benefit plans pay retirement income tied to the number of years of service an executive completes with an employer. Many mid-level executives are faced with a unique challenge. Often they have not accrued enough years of service with their current employer to have earned a vested benefit and will lose needed retirement money if they leave. By making up for these lost years of service, a SERP can provide the encouragement the executive needs to join the new employer.

To Reward Valuable Executives A SERP can be used to reward key executives for outstanding service to the employer. A nonqualified SERP allows the employer to pick and choose those executives the employer feels should be rewarded with additional retirement benefits.

As Part of an Early Retirement Program A SERP can be a useful tool when its time for an employer to make room for a new generation of management or when faced with the reality of downsizing due to change in the market. A SERP provides additional retirement benefits that help executives to realize they are financially secure and ready for retirement, while allowing the employer to reach out to up-and-coming talent.

To Act as Golden Handcuffs A successful executive will always be the target of other companies wishing to benefit from his or her abilities. If an executive risks losing a substantial amount of retirement benefits by leaving the company, he or she might rethink a career move. Therefore, a SERP designed with a vesting schedule can be a very successful retention tool.

Uses of SERPs

For agent/registered representative use only. Not for public distribution.6

6 The cash values of the corporate-owned policy grow income tax deferred and are general assets of the employer.

7 Policy loans and partial withdrawals may vary by state, reduce available surrender value and death benefit or cause the policy to lapse. Generally, policy loans and partial withdrawals will not be income taxable if there is a withdrawal to the cost basis (usually premiums paid), followed by policy loans (but only if the policy qualifies as life insurance, is not a modified endowment contract and is not lapsed or surrendered).

8 Death benefits from life insurance will be received income tax free if the policy purchase complies with the requirements