Page 349 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

Chapter 6. Employee Benefits and Perquisites 335

Supplemental Executive Retirement Plans
Supplemental executive retirement plans (SERPs) are pension plans that begin where the
qualified plan ends. Stated another way, these are benefits in addition to the qualified
defined-benefit and defined-contribution plans. These are often called top-hat plans and are
limited to a select group of management or highly compensated employees. The Department
of Labor expanded this definition to require that such persons must be able to affect or
substantially influence the design and operation of the plan, accepting attendant risks.
Companies need to be certain they are in compliance with ERISA to avoid problems with the
Department of Labor.
As SERPs are nonqualified, the company’s tax deduction is deferred until the executive
receives the benefit. However, the expense will be accrued and charged to earnings during the
accrual period. There are two types of SERPs: restorations and add-ons. The first restores
benefits limited by legislation; the second provides executives with a targeted pension benefit.

Restoration Plans. These plans “restore” pension benefits that were lost when the com-
pany pension plan formula provided an amount in excess of that permitted by the IRC
qualified pension plans. Restoration plans are also called 415 plans, referring to the section
of the IRC that inspired them. To maintain tax-qualified status, Section 415(b) limits the
annual benefit from a defined-benefit plan to $160,000 (adjusted for inflation) or 100 percent
of the participant’s average compensation for the highest-paid three years, whichever is less.
For defined-contribution plans, Section 415(c) of the IRC limits the annual addition to the
lesser of $40,000 or 100 percent of the participant’s compensation. Similar restoration plans
can be used when there are limits on the amount of pay that can be used in the calculation.
These are also called excess plans, referring to the benefit in excess of the statutory limit.
However, the name may imply “additional” and sounds similar to “excessive.”
ERISA sets limits inside the qualified-plan formula and prohibits payments or set-asides
in excess of those amounts. Failure to do so would disqualify the plan, forcing the company
either to delay taking a tax deduction or forcing individuals to incur a tax liability on amounts
deferred. Because of the severity of losing the qualified plan status, companies chose instead
to restore the lost benefit through a nonqualified plan. For example, if the formula for the
defined-benefit plan generated a $500,000 pension but the allowable ERISA payout was
$160,000, then $160,000 would be paid from the qualified plan and $340,000 from the
nonqualified, restoration plan.
The same principle would apply to a defined-contribution plan. For example, assume the
401(k) cash or deferred arrangement (CODA) was capped at a maximum annual amount of
$10,000. An executive earning $500,000 with a plan that matched dollar for dollar on the first
5 percent set aside would be limited to a 2 percent deduction. By setting up a restoration plan,
the additional 3 percent (along with a company match of 3 percent) would be a nonqualified
deferral.
Some might choose to adopt alternative maximums (such as two times ERISA), although
one could question whether these maximums have any meaning. The majority take the view
that (1) there is a maximum of plan benefits simply through the application of the plan for-
mula, (2) there is no reason for executives to receive less benefit in terms of the formula than
anyone else, and (3) establishing a maximum within the plan requires a logic for that value.
Furthermore, if the maximum is expressed in absolute dollars, the shareholders must period-
ically be requested to increase the amount—an act that consumes time, effort, and expense.