Executive Retirement Benefits

Most companies have qualified retirement plans to provide employees with a source of income when they retire. These plans are “qualified” in the sense that they receive preferential tax treatment that is not available to other forms of compensation, provided IRS regulations are met. One of the key requirements for qualified plans is that they be made available to all employees. Another aspect of qualified plans is that there are limits on the amount of money that can be contributed to the plan annually or be counted towards determining the benefit accrued under the plan.

The two most common types of retirement benefits are defined contribution plans and defined benefit plans. A defined contribution plan is an arrangement where employees are eligible to save a portion of their current compensation for retirement and receive additional contributions from the company. When people think of defined contribution plans, they primarily think of 401(k) plans. Under a standard 401(k) design, the employee is provided with the opportunity to contribute a percentage of salary and/or bonus into their own 401(k) account. The company will typically make a contribution into the account, often defined as a percentage match of the employee’s contribution (e.g., 50% match of the employee’s contribution up to a maximum match of 3% of the employee’s salary). In some cases, companies will contribute on behalf of employees without requiring the employee to make their own contribution to the plan.

Most companies will provide employees with a choice of investment options within the 401(k) plan, often consisting of an interest-bearing account pegged to a federal treasury rate, mutual funds, and/or company stock. In the past, many companies directed their match into company stock. However, following several high-profile corporate collapses (e.g., Enron), this practice is no longer popular. An important benefit of an account within a qualified plan is that, while the company is responsible for administering the accounts, the funds in the accounts belong to the employees once vested and are portable if/when employees leave the company. In addition, the 401(k) assets are not treated as assets of the company, and as such, they are not subject to creditor claims in a bankruptcy proceeding.

The less popular plan, a defined benefit plan, is an arrangement that provides employees with a pre-established amount of income after they stop working. Under such a plan, the company bears the investment risk, making them potentially more expensive than defined contribution plans. For example, if plan assets do not appreciate sufficiently to cover the cost of the promised benefits, the company will be required to increase contributions. Due to the greater expense associated with defined benefit plans, many companies have closed plans to new participants or terminated plans by ending future benefit accruals. As a result, defined contribution plans have become the core retirement vehicle for most employees.

In defined benefit plans, the amount of the annual benefit will be a function of three factors: the employee’s salary or annual cash compensation over a period of time (e.g., last five years of employment), the number of years of service the employee had with the company, and the age of the employee at retirement. A typical formula might determine an employee’s benefit as 1% of final average salary and bonus for each year of service up to a maximum of 40 years of service. Final average salary and bonus could be the average earned over the last 3–5 years of service prior to retirement. For a long-service employee, a retirement plan with this structure could provide the employee with retirement income equal to 40% of salary and bonus.

If the employee retires early, the size of the benefit will be reduced to reflect the additional years the employee will receive benefits and potentially to penalize the employee for retiring before the full retirement age under the plan. Defined benefit plans generally provide the benefits as an annuity, with the payment of benefits ceasing upon the death of the retiree (and his/her spouse if the plan provides a survivor benefit). This effectively insures the employee against uncertainty over how many years he/she will survive beyond the retirement date. Alternatively, some companies will provide a “lump-sum” option that provides the employee with the option to receive the actuarial present value of the retirement benefit upon retirement. In this case, employees are responsible for investing the lump-sum value during retirement and they bear the risk of outliving their funds. Amounts in qualified defined benefit plans are not subject to forfeiture in the event of a bankruptcy and are generally insured (within limits) by the Employee Retirement Income Security Act (ERISA).

Supplemental Executive Retirement Plans

As mentioned earlier, there are limits on qualified plans to ensure that excessive benefits are not provided to high-income employees. For example, as of 2026, the maximum annual contribution for a defined contribution plan like a 401(k) is $24,500, with an additional “catch-up” contribution of $8,000 available to participants age 50 or older and of $11,250 for individuals ages 60 to 63. "The “catch up” amounts must be made to a Roth IRA for individuals with compensation of more than $150,000. The maximum compensation included in a benefit formula for a defined benefit pension plan is $360,000 for 2026." Because of these limits on qualified plans, many companies have added non-qualified plans targeted at the executive population called supplemental executive retirement plans (SERPs). SERPs provide benefits to high-income employees beyond the qualified plan limits. These plans can serve either one of two purposes:

• Restoration Plans: Mirror the qualified plan that all employees of the company receive, but provide for the continuation of benefits beyond the caps on contributions/benefit formulas under the qualified plans
• Supplemental Benefits: Provide special benefits to executives beyond the benefits provided to other employees at the company

While SERPs are frequently criticized by shareholder advisory firms, the rationale for providing a restoration plan to executives is sound. The benefits provided under restoration plans simply maintain the same structure as the qualified plan, as if the qualified plan limits on maximum contributions or allowable compensation did not exist. In this sense, these plans are not really providing executives with something extra that is not available to other employees. Instead, restoration plans put them on similar footing relative to other employees but recognize their higher income levels.

Criticism of SERPs may be more justified, however, when special benefits are made available to executives that are not available to other employees. Several varieties of these arrangements exist:

• Additional Service Credit: At times, senior executives that join a company later in their careers may be credited with additional years of service under the SERP. Generally, the rationale for providing the additional service credit is to make up foregone benefits from a prior employer or as a carrot for recruitment. Additional service credit can be very valuable to an employee and can lead to large changes in pension values, which are reported by companies in the Summary Compensation Table (SCT).
• Enhanced-Benefit Formula: When the company has a more generous benefit formula for executives under the SERP than employees receive under the qualified plan, it has adopted an enhanced-benefit formula. For example, an executive could receive 1.5% of compensation for each year of service under the SERP vs. 1% of compensation under the qualified plan.
• Enhanced Contributions: Companies may make larger contributions on behalf of executives than for other employees under the qualified plan.
• Frozen Qualified Plan/Unfrozen SERP: In some cases, to manage plan costs, companies may freeze the qualified plan so that new participants are not allowed to enter the plan or to limit future benefit accruals for existing participants. Disparate treatment exists when, under these circumstances, the company nevertheless allows executives to continue to accumulate benefits under the SERP.
• Long-Term Incentive Included in Benefit Calculation: In rare cases, companies will include the value of long-term incentive cash payouts in the definition of compensation for purposes of calculating the pension benefit.

From the perspective of committee members, SERPs can be challenging to manage. The value of a SERP can be substantial; many examples of SERPS valued in the tens of millions of dollars exist for CEOs with significant years of service. The methodology used to determine the present value of the benefits relies on actuarial calculations that can be volatile from year to year. At times, executives with large SERPs may appear overpaid due to changes in the discount rate used to calculate the pension value, rather than the accumulation of incremental benefits. In addition, the value of SERP benefits is somewhat difficult to benchmark because the values for different CEOs will depend on their specific circumstances including age, tenure, and compensation, as well as on the differences in the designs of the SERP programs.

We recommend caution when implementing any new SERP arrangement with executives. SERPs are generally viewed by shareholder advisory firms and shareholders as a form of non-performance-based pay that insulates executives from performance accountability. Where long-term executive retention is the goal, the use of long-term, equity-based incentives, rather than a SERP, is preferred by committees and shareholders. In addition to the concerns already raised, SERPs constitute deferred compensation subject to complicated tax rules under IRC Section 409A. SERPs also are subject to greater risks because unlike qualified plan assets, assets held in a SERP will be subject to general creditors in the event of a bankruptcy.

If your company has an active SERP program, it is critical to understand how changes to the compensation of senior executives will impact the value of the SERP. Because SERPs often depend heavily on final compensation, changes in that compensation can have a very large impact on the present value of the SERP.

Beyond SERPs, other forms of executive benefits include supplemental life insurance, supplemental health insurance, supplemental disability insurance, and executive physicals. Most forms of supplemental executive benefits have fallen out of favor and, in most cases, compensation committees will be better off if executives purchase these benefits on their own. The lone exception is the executive physical, which is a relatively low-cost benefit that can contribute to the health of senior executives by encouraging physical exams at regular intervals.

Key Questions for Committee Members to Ask:

• Do our SERPs restore benefits to executives beyond qualified plan limits or provide benefits beyond what rank-and-file employees receive? If so, why?
• What forms of compensation are counted towards retirement benefits under the SERP? How will changes in compensation impact the present value of the SERP benefits?
• For new hires, is restoration of SERP benefits from their prior employer necessary? Could we replace the value of the SERP with a different, more performance-based form of compensation?
• Are any other executive benefits provided? What is the business rationale? What is the value of these benefits?