This section of the Examiner's Guide provides exam staff a basic understanding of senior executive benefit plans as they relate to retirement or insurance benefits. It is not an all-inclusive list of available retirement or insurance benefits, and should not be used as legal or tax related reference materials.
Nonqualified Deferred Compensation
Nonqualified deferred compensation plans are limited to a select group of credit union employees.1 Internal Revenue Code Section 457 governs tax-exempt employers, such as credit unions. Plans used by credit unions can be “eligible” or “ineligible,” which primarily dictates tax treatment at the time of vesting.
Section 457(b) Plans
Section 457(b) plans are considered “eligible” plans. Similar to a 401(k), there are annual limits and vesting. The employee, employer, or a combination of the two can contribute into the 457(b) plan.
The employee can direct investments in the 457(b) and maintains the investment risk similar to a 401(k) plan. However, the investments are carried on the credit union’s balance sheet and the employee is a general creditor if the credit union fails before the employee takes distributions. Benefits associated with a 457(b) plan are taxed when received by the employee.
Section 457(f) Plans
Section 457(f) plans are considered “ineligible” plans because they do not meet the restrictions of 457(b) “eligible” plans. Unlike 457(b) plans, there are no contribution limits, and taxation is at time of vesting.
457(f) plan assets typically remain on a credit union’s balance sheet until vesting. Once vested, there is typically a distribution because vesting is a taxable event for the employee. Assets in the 457(f) plan that are not vested must be subject to a “substantial risk of forfeiture” in order not to be subject to a taxable event for the employee. 457(f) plans can be structured as a defined contribution, defined benefit, or a hybrid of the two.
457(f) plans generally have larger balances than 457(b) plans and do not necessarily need to be funded by specific investments.
Split-Dollar Life Insurance
Split-dollar life insurance is an agreement in which a credit union employee (typically a senior executive) and the credit union “split” the “dollar” an insurance policy provides. Split-dollar insurance is not a type of insurance policy, but an agreement that can apply to any cash value policy (as opposed to term policies). For more information, see a description of the various types of cash value insurance policies.
Split-dollar life insurance falls into two general tax regimes—economic benefit regime, and loan regime. The regime that applies depends on whether a credit union or an executive owns the policy. A third regime, the non-equity regime, applies to arrangements where an executive’s only interest in a policy is to designate the beneficiary of a portion of the death proceeds. The non-equity regime applies irrespective of policy ownership.
Economic Benefit Split-Dollar
An economic benefit split-dollar policy is one owned by a credit union whereby it endorses specific rights of the policy to the senior employee. The credit union can endorse the cash value and death benefit to the employee/employee’s beneficiary. The contractual terms are between the credit union and the senior employee.
Loan Regime Split-Dollar
With loan regime split-dollar, the insurance policy is owned by a senior employee who in turn assigns it to the credit union as security for a loan used to pay the policy premiums. The terms of the contract stipulate the credit union’s and the senior executive’s respective rights under the transaction. Loan regime split-dollar plans are more prevalent than economic benefit split-dollar plans.
Under loan regime split-dollar policies, loan rates are generally tied to IRS-published rates to avoid unfavorable tax treatment. In some cases, the loan interest is imputed and will be treated as taxable income for the senior executive. Split-dollar loan rates are established by the credit union. Exam staff should not take exception to the loan rates unless the rates pose a safety-and-soundness risk.
Favorable tax treatment (such as non-taxable distributions) is a primary driver for why loan regime split-dollar policies are more commonly used. In a properly structured program, a senior executive borrows against a policy at retirement and effectively receives tax-free pension payments. The loan is paid in full from the death benefit proceeds when the covered executive dies and the benefit is resolved.
Loan regime split-dollar programs are not without risk. Poorly structured and/or underperforming policies can result in loan losses for the credit union and a taxable event for the covered executive. Unsuccessful programs can result from substandard returns on the permanent insurance policy and/or excessive borrowings by the covered executive (against the policy), undermining the policy’s economic ability to safely fund the benefit. To guard against this risk, it is important for the credit union to select the appropriate policy, and to have a legal arrangement that protects the credit union’s interests.
Non-Equity Regime Split-Dollar
A non-equity regime split-dollar policy is one where a senior employee’s beneficiary receives a specific amount of death benefits. The senior executive has no direct interest in the policy’s cash value.
Last updated September 25, 2017
