SERP Sales Shift Direction

Not all SERPs are of the DB variety. A still small but growing percentage of companies are shifting to account balance SERPs (just as they are to 401(k)-style deferred comp) to reduce future payouts and, thereby, boost earnings. These non-DB packages include most prominently cash balance plans, wherein executives are given an account that grows by an annual credit, say, 3% of the executives' pay each year, plus interest. When they leave the job, they can roll the amount into an IRA or cash out.

In the Todd survey, 11% of the companies subscribe to an account balance plan. Just 2% of respondents use a formula-based or other discretionary contribution.

"With an account balance SERP, dollars go into the plan, and whatever the account grows to is the amount distributed, so there is no promised benefit," says J. Saunders Wiggens, a financial planner at The Actuarial Consulting Group, Richmond, Va. "The flexibility that many of our clients desire favors the account balance SERP."

Irrespective of plan type, a growing number of businesses of all sizes are tying payouts to a tenure-based vesting schedule (the proverbial "golden handcuffs") and/or performance, wherein the executive or company must meet certain benchmarks before benefits are distributed. Most companies, as documented by studies from Clark Consulting and others, are also funding their non-qualified plans with life insurance because of the vehicle's tax advantages (i.e., tax-deferred growth of policy cash values and income tax-free distribution of death benefits).

The type of policy will vary by plan. Within the deferred comp space, variable universal life policies are common. But among SERP plans (especially DB SERPs), UL policies (and, to a smaller extent, whole life policies) predominate. These policies, Shapiro observes, are not subject like VUL contracts to the gyrations of the stock market, thus making plan funding requirements more predictable.

To be sure, life insurance is not always the favored funding mechanism. Mutual funds and other investment vehicles may be utilized depending on the type of business, tax situation, insurability and time horizon to retirement for key employees covered under the plan, experts say. Dalgliesh observes that a life insurance policy may make little sense for the business owner who is in poor health and stands to pay sky-high premiums; nor for the executive who is only 4 years from retirement and will derive little tax leverage from the policy.

Also to consider is the number of plan participants. Wiggens says life insurance becomes more compelling as the number of executives to be covered grows. Dollars flowing into an insurance-funded plan rise in tandem, yielding ever greater tax leverage for the business. But for very small firms, Wiggens finds that exchange-traded funds can also be tax-efficient because of the vehicles' low internal expense ratios.

"A lot of producers come to the table with a predetermined notion of what they want to sell as opposed to doing an in-depth job of deciphering what is best for the client," says Shapiro. "Often, the agent never asks whether the company anticipates a change in its tax bracket, which can change dramatically from year to year."

Ditto as regards the tax laws and regulations to which the business is subject. Sources say the Pension Protection Act of 2006 has lent greater flexibility to plan and product design (as, for example, in the development of life products with long term care riders). And advisors generally laud IRC section 409A, an outgrowth of the American Jobs Creation Act of 2004, which sources say has provided greater "clarity" to rules governing non-qualified plans.

Not everyone agrees.

"Section 409A has been a real killer in the small business market," says Weinbaum. "People don't want more complications and more regulations, like a 20% penalty tax if you don't do the plan right. We're seeing a lot less [non-qualified] business–maybe 60% to 70% less–than we did before 409A.

"One of the top 5 priorities of the Small Business Council of America, of which I serve as a board member, is to get Congress to create an exception to 409A for privately held business," he adds. "The clients of the organization's leaders are finding [409A] to be a huge problem."

IRC hurdles aside, advisors face other potential challenges. Among them: winning over key decision-makers or achieving consensus among executives who may be at odds over plan design. They also need to ensure that plans, once implemented, are properly administered (usually by a qualified third-party administrator) and kept up-to-date through regular (often annual) reviews.

Producers also need be mindful of ancillary business opportunities–buy-sell agreements, health plans and personal financial planning services for key executives–to be had after working on a SERP plan.

Says Shapiro: "I can't tell you how many producers enroll executives in non-qualified plans and never think of them again as clients. When they do that, they're leaving money on the table."