Nonprofit Boards and Executive Contracts – Episode 6: Supplemental Executive Retirement Plans (SERP)
The last chapter in “Nonprofit Boards and Executive Contracts” covers the Supplemental Executive Retirement Plan, or SERP, an element of the employment contract that offers significant advantages to both the CEO and the board.
For the CEO, the SERP allows for an individual to set aside, or defer, a significant amount of ordinary taxable income until a later date, thus delaying paying taxes on a portion of regular income and allowing that income, if invested, to grow tax-free, until a ‘date certain.’ It is called supplemental because it is in addition to the regular 403 (b) or 401 (k) offered by many nonprofit employers; for a higher-paid executive, it is a powerful way to save for retirement and avoid current taxes. Two SERPs are available to nonprofit executives, 457 (b) and 457 (f).
The 457 (b) is a simple vehicle that only requires board approval and can be contributed to by either the executive or the board or both; it allows for the executive to defer or save an additional amount of earnings (the amounts change annually they are currently between $20,500 and $27,000) tax deferred. If the executive is no longer employed by her current organization, in most cases, it is rolled over into an individual IRA. I strongly recommend that CEOs investigate this vehicle for themselves and their senior staff. The organization’s accounting firm should be part of setting it up and monitoring its administration as the laws keep changing.
The other, less known, and more dynamic SERP, is a vehicle that benefits the CEO and the board, the 457 (f). Even with a 403 (b) and a 457 (b), the well-compensated CEO still has less ability to defer taxable income than the corporate executive. The 457 (f) addresses this and creates a “golden handcuff” that motivates the CEO to remain employed by the organization, thus benefitting the board. Remember, even with an employment contract, the CEO can always choose to leave the organization, usually with few financial penalties.
The 457 (f) allows the executive to defer up to the entire amount of her annual salary. In many cases, our clients typically defer 10% to 25% of their salary, which is not taxed at the time. For it to be “tax-deferred,” there must be a “risk of forfeiture.” In the corporate world, that is usually defined as company bankruptcy. But since nonprofits rarely go into default, the IRS definition for a 457 (f) “risk of forfeiture” is leaving the employ of the organization before “a date certain.” Yes, the rules are somewhat complicated, but essentially, the board and the CEO agree, contractually, that the CEO will remain employed by the organization for a set time – at least three years, usually longer. If the employee leaves to take another position, for example, the amount in that 457 (f) is lost or forfeited. The “date certain” may be extended (usually with a renewal of the employment contract), and so, over time, the CEO creates a sizable tax-deferred “nest egg.” That nest egg is also a “golden handcuff” compelling the CEO to remain with the organization or lose the entire amount in the 457 (f). There are exceptions to forfeiting the money (if the CEO is fired for “no reason” or for “death or disability”). Even so, the 457 (f) remains a tidy, robust retirement and savings benefit for the CEO and perhaps the only retention tool for the board. An experienced nonprofit attorney or accountant is required to create the legal documents.
A final note about the optics of a SERP. I am sometimes called by reporters asking me, for example, why “the local museum director earned $3 million last year.” Likely, that year, the director collected the 457 (f) at retirement. The 457 (f) annual payment is recorded and counted as compensation on form 990 each year (even though, technically, the executive doesn’t own it), and the total is recorded when it is collected by the employee.
I trust that this last chapter, and the five preceding it, have been helpful to nonprofit CEOs and boards. Executive nonprofit leaders change the world for the better through their organizations, helping those in need, educating generations, uplifting our spirits through arts and culture, curing diseases, and advocating for those whose voices are not heard. The partnership between the CEO and the board is critical, and the nonprofit executive contract strengthens that partnership.
James Abruzzo, Global Head, Nonprofit Practice, DHR Global is also one of the leading contract negotiators and compensation consultants for nonprofit boards and CEOs. He is not, however, an accountant or lawyer – the advice above is not cover either area.