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Preserving the wealth in supplemental retirement plans.
When Congress enacted legislation restricting qualified retirement benefits, employers responded by creating nonqualified supplemental executive retirement plans (SERPs). These plans provide a tax-efficient way to restore benefits lost due to the restrictions in IRC sections 415 and 401 (a) (17).
As Congress has continued to lower qualified plan limits, SERPs have become an increasingly important part of a corporate executive's wealth accumulation strategy Today it's common for more than 80% of an executive's retirement benefits to be delivered through nonqualified plans.
Despite the benefits, many executives with sufficient retirement income are concerned about the tax inefficiency of SERPs as a wealth transfer vehicle. Multiple taxation and lost earnings can erode up to 85 cents of every dollar of SERF income transferred to an executive's descendants. These taxes often include:
* Income tax at receipt of SERP benefits.
* Income and capital gains taxes as assets accumulate following retirement.
* Estate, gift and possibly generation-skipping transfer (GST) taxes at transfer.
Many companies are implementing programs to help executives with this tax planning problem. One approach to maximize wealth for future generations and create liquidity to pay estate taxes is called a "SERF swap." Also known as a preservation of wealth plan, a benefit exchange or an excess benefit swap, the arrangement allows participants to exchange heavily taxed retirement benefits for employer-funded life insurance contracts. The favorable tax treatment of life insurance can help produce significantly more wealth for future generations.
A SERP swap is a complicated financial, tax and accounting strategy. Experienced practitioners must help clients determine what benefits to exchange, plan mechanics and the optimal life insurance arrangement. It's also important for financial managers to understand how these arrangements work so they can help their employers assess the consequences of offering SERP swaps to the company's key executives.
THE PLAN MECHANICS
An executive's financial position will determine the advisibility of his or her participation in a swap. A participant must be able to maintain a comfortable retirement without the entire SERP, since the decision to forfeit benefits is irrevocable. Companies often designate these income sources as eligible for a possible exchange:
* Deferred compensation balances.
* Accrued SERF pension benefit obligations.
* Stock option gains and restricted...