Times have changed since an executives income consisted simply of salary and bonus. Recent reports say as little as 20% of a top executives income is now derived from salary.
The emergence of incentive pay–bonuses that exceed base salary, significant and multiple supplemental retirement plans, options that far exceed other income–have created a level of wealth previously unheard of for corporate executives.
Thus, after years of effort dedicated to accumulating assets and building wealth, executives are increasingly turning their attention to the preservation of that wealth.
Obviously, this has created new planning opportunities. One concept growing in popularity due to its dramatic results is the “SERP Swap” or “Benefit Exchange.” While this technique is not new, it is finding increasing popularity due to the proliferation of Non-Qualified (NQ) Plans.
Designed to offset 415 limitations on Deferred Benefit Plans, to overcome the limitation of a 401(k) plan, or to simply allow highly compensated executives to shelter income, the balances of these plans frequently dwarf their qualified plan counterparts.
Yet, many executives no longer need this NQ income to supplement their retirement income and would prefer to continue the deferral to avoid the corresponding income tax, or in many cases, simply pass these assets on to their heirs.
Therein lies the problem. Like their qualified plan counterparts, NQ plans are outstanding vehicles for wealth accumulation but extraordinarily poor for wealth distribution as they face both income and estate tax. This dual taxation often strips away up to 75% of the NQ assets, leaving a mere 25% for the family.
Fortunately for the executive in a financial position to forego the supplemental retirement income, the NQ assets can be repositioned or exchanged in a way to bypass both income and estate taxes.
A Benefit Exchange, or SERP Swap, is essentially an election by an executive to exchange all or a portion of his NQ benefits in favor of a split dollar life insurance program–swapping heavily taxed and unneeded supplemental retirement benefits for an asset that avoids income and estate tax and, quite possibly, gift and GST as well.
When combined with the additional leverage of life insurance, a true windfall is created for the executive and his family. In fact, the exchange concept can provide leverage and tax benefits available through no other medium.
The Company’s Perspective
From the employing companys perspective, the exchange can be a cost neutral exchange of benefits. That is, the net present value of the new benefit is designed to match the net present value cost of the existing benefit. In addition, the company will actually receive a benefit, as the liability already booked for the non-qualified plan will be released, creating book income for the company.
Thus, the exchange offers the company an opportunity to provide a unique and cost-effective way to customize a benefit for its top executives that better meets their individual needs and desires–to preserve their wealth for their families.