How to Make Supplemental Executive Retirement Plans Work for You and Your Bank

Supplemental Executive Retirement Plans (SERPs) are a valuable compensation tool that banks can use to attract and retain executive talent. SERPs are nonqualified deferred compensation arrangements that are non-elective, meaning the bank is responsible for contributions to the plan.

With a well-designed SERP, your bank can garner quite a bit of success. Unfortunately, improper design of these plans can result in significant expenses for banks without providing the intended retention value. As we move into 2017, here’s what you need to know to avoid the common issues that arise with SERPs and to structure your bank’s executive benefit plans properly.

Common SERP Challenges to Understand and Avoid

Many banks do their due diligence and pay close attention to the expenses they will incur as a result of their benefit plans, but this hasn’t always been the case. When SERPs rose in popularity, many banks entered into inappropriately designed plans without understanding their implications. SERPs therefore have some lingering reputational issues that are not entirely fair. Don’t believe the bad press that SERPs have received! It’s true that in 2016, we saw a number of problems related to SERP plans, but these are avoidable. The real problem isn’t SERPS—it’s poor design.

A poorly designed SERP can accelerate vesting schedules in the event of early retirement or cause banks to pay benefits in excess of 100 percent of final salary. Problems also arise due to IRC Section 280G (which deals with golden parachutes) in the event of a change of control. Additionally, many poorly-structured SERPs were designed solely with the placement of Bank Owned Life Insurance (BOLI) in mind, ignoring the strategic purpose and future impact.

The primary concerns are the following:

  • Equity-based SERP designs
  • Banks absorbing mortality risks for lifetime benefit plans
  • Not considering 280G excise tax concerns in the case of M&A activity
  • Unreasonable benefit structures that are either too lucrative or conservative
  • Defined benefit structures whereby a SERP benefit is contingent upon a final pay calculation

You can understand why some boards have been soured by a bad experience and vowed to never implement another SERP plan at their bank. However, from a strategic perspective, this is a mistake that will hinder the bank’s ability to retain and recruit the talent necessary to stay competitive. Instead, focus on structuring SERPs properly to assure they will work for your bank.

Key Considerations for Implementing Well-Designed SERPs

A SERP isn’t the answer to all the retention or recruitment issues, but it is a tool that should be used to complement the other components of compensation. With careful structuring, your SERPs can provide substantial benefits for your bank.

Let’s address a few key considerations that will enable you to implement well-designed SERPs:

  • Know what your expense is going to be. The benefit should be fixed day one, plain and simple.
  • Understand the potential 280G impact. This is important regardless of the probability of a change in control.
  • Explore all financing options. BOLI is not the only tool available for bankers. Know that financing tools exist to reduce plan expense and provide a lifetime benefit with a fixed cost through proven methodologies.
  • Understand the strategic purpose behind the benefit plan structure. Conduct peer compensation studies to ensure that the benefit and compensation are reasonable and competitive.
  • Make sure your bank is protected in the event of premature death. However, don’t allow life insurance to drive the design of your plans.

If you currently have a SERP plan that doesn’t incorporate these features, it’s time to take a hard look at your plan design and make changes for the better.

Although IRC 409A (which regulates the tax treatment for nonqualified deferred compensation plans) imposes limitations on plan design changes, there are a number of strategies to help reduce the general plan expense, mortality risk concerns, 280G exposure, and other issues without violating IRC 409A. There are hedging vehicles in the market to generate efficiencies at the benefit expense level. Consult with a compensation professional to help you navigate these waters to ensure your success.

The Takeaway: Explore Your Options and Design Carefully

Many banks use SERPs effectively as part of their executive compensation strategies. A bad experience should not deter you from exploring the positive aspects of SERPs, nor should you let what you’ve heard about poorly designed plans scare you away. That said, a SERP can be complex and should be designed objectively by compensation professionals. If you explore all financing tools to make sure the bank is getting the most efficient design, your bank will be in an excellent position to accomplish your goals.

Supplemental executive retirement plans