SERP as a Component of an Executive Compensation System
In today’s competitive environment, financial institutions must attract and retain key executives. Keeping the right people on the bus is one of the most important drivers of a successful bank. Supplemental executive retirement plans (SERP), when implemented as part of a compensation package, can help keep key executives in place and help directors manage risk.
One of the challenges facing executives is planning for retirement. Most highly compensated executives cannot save enough money through traditional, qualified plans—such as 401(k) plans—to adequately provide for retirement; studies show quality of living during retirement requires 70 percent to 80 percent of preretirement income. Further, Social Security rules don’t favor higher-paid individuals. A SERP can provide key executives an additional retirement payout, increasing the bank’s ability to retain their services.
A SERP is an employer-sponsored deferred compensation arrangement designed to provide the key executive with supplemental retirement income. Typically, the key executive does not contribute to the arrangement; rather, it’s funded by the employer. A SERP usually is designed as a nonqualified benefit arrangement, setting forth a defined amount of payment and a defined payment period. The SERP arrangement is flexible and only can be offered to select employees. Further, the amounts to be paid and payment period are flexible—in general, monthly payments are made to the retired executive for a predetermined period of time.
Most of these types of arrangements are to be accounted for on an accrual basis in accordance with the terms of the individual arrangement, as long as the arrangements together do not constitute a plan, in which case the accounting could be different. An annual service cost for the expected future benefit must be accrued with interest during the employee’s active period of service to the employer in a systematic and rational manner.
Since the expense is recorded over the employee’s active service period, starting these arrangements at an early age provides an increased expensing period. Modified forms of these arrangements also can help younger executives with expenses such as college education, e.g., the arrangement could provide for certain payouts (prior to retirement) to the executive when the education costs are going to be incurred.
Many financial institutions acquire bank-owned life insurance (BOLI) contracts to assist in funding the SERP, but the decision to invest in a BOLI contract is distinct from the decision to provide a benefit to an executive under a SERP; a bank can have one without the other.
Executive compensation plans need to address a number of issues—retirement is just one factor. A SERP arrangement can be an effective mechanism to keep key executives at a financial institution, helping directors manage risk while providing the key executives with additional retirement planning security.