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SERP Swaps Can Help Maximize Wealth From Non-Qualified Plans

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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.

Selection Of Insurance Product

When evaluating the insurance product(s) to be used, it should be recognized that the size of most exchange transactions creates the opportunity for the use of specialized, institutionally priced products designed specifically for the affluent and corporate market. These products will have lower mortality and expense charges than traditional off-the-shelf retail products designed for and sold to the mass market.

This can be especially important in the creation of high early-year cash value and avoidance of surrender charges in order to avoid negative impact to the companys balance sheet.

Tax Issues

The most obvious issue is how the exchange concept is impacted by IRS Notice 2002-8. In spite of this Notice, swaps are still a viable and effective wealth transfer tool. Typically, a SERP Swap isnt intended to be used as a retirement strategy, and the Notice certainly further puts the nails in the coffin on this issue through the negative treatment of equity split dollar.

If the executive is attempting to squeeze equity out of the SERP on a tax advantaged basis in order to have a more tax efficient retirement vehicle, the Notice discourages this by either taxing the equity at rollout or treating the arrangement as a loan.

In order to comply with the new Notice, any split dollar arrangement put in place after Jan. 28, 2002 should be structured either as a loan or by the endorsement method. The issue at hand between these two methods is the general costs involved.

The loan interest on a long-term basis could possibly be more costly than the increasing economic benefit on an endorsement basis. Prior to final regulations, one could choose to treat the arrangement as collaterally assigned equity split dollar. This is certainly not in compliance with Notice 2002-8, but could possibly be defensible. All factors of the situation, including age, risk class, amount of insurance, etc. will help determine which route is most efficient.

Designing a split dollar plan in tandem with a SERP Swap should have more flexibility with a private rather than a public company. Most public companies will not allow an arrangement to remain in effect until death. This means the arrangement will have to be terminated, which will steer the way the split dollar plan is designed from the outset.

On the other hand, a private company may allow an arrangement to exist until the employees death, which could prove to be positive as it relates to the tax treatment of the arrangement.

Other tax issues that should be considered primarily involve the control an executive may be deemed to have over the NQ assets. These include actual and constructive receipt, Section 83 income issues and possible assignment of income.

Most legal and accounting practitioners seem to concur that properly structured, the mere exchange of benefits should not trigger these issues. Certainly, all issues should be reviewed on a case-by-case basis.


Although Notice 2002-8 will cause some changes as it relates to split dollar arrangements, the Benefit Exchange or SERP Swap concept still presents a very powerful wealth transfer tool. For the executive in a position to forego the supplemental retirement income, the concept is without peer for a tax efficient transfer through the avoidance of income, estate, and gift tax.

From the companys perspective, the exchange allows the customization of benefits for the individual executives at no additional cost to the company. Obviously, every situation has different fact patterns, assumptions and end goals, but the exchange concept remains without peer for a tax efficient transfer of NQ plan assets to an executives heirs.

Michael J. Brink, CLU, and Bo Wilkins, CLU, ChFC are with the insurance advisory firm of Nease, Lagana, Eden & Culley, Inc., Atlanta, Ga., a member of the M Financial Group. You can contact Michael at [email protected] Bo can be reached at [email protected]

Reproduced from National Underwriter Life & Health/Financial Services Edition, March 4, 2002. Copyright 2002 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.

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