By Ray Birch
BIRMINGHAM, Ala.—Split-dollar life insurance has become one of the most popular ways to provide credit union executives with a retirement benefit, but the fast growth of the plans over the last 10 years is now raising questions over whether enough attention is being paid to the agreements to ensure they pay off, according to experts.
Dennis Dollar, who now leads the Dollar Associates consulting firm and who previously was chairman of NCUA, told CUToday.info that unless the polices are managed properly, the only winner in the end will be the IRS, not the credit union or the executive.
According to Dollar, there are now approximately 1,000 credit unions now with split-dollar executive benefits plans in place for their senior executives. That number was about 250 just 10 years ago. Dollar estimated the amount invested by credit unions in the plans has grown to almost $7 billion from about $600 million a decade ago.
Bursting on to the Scene
“These types of plans were not very common until 20 years ago when the IRS authorized them. But they have become crucial as the executive recruiting and retention market has become so very competitive,” Dollar said, adding its critical the plans be set up on the right way in order to comply with IRS rules.
“The growth in executive benefits plans over the past 10 years has been dramatic, but it has also been necessary to recruit, retain and reward top-quality talent,” said Dollar. “Split-dollar plans have become the most popular vehicles, because their structure and the IRS rules enable them to provide a top-level benefit but not to have it taxed as compensation.”
Dennis Dollar
Growing Interest
Dollar said many of his clients use split-dollar for executive benefits and even more are seriously considering them.
“A credit union must structure them completely, and needs to contrast and compare—with solid guidance—to make sure they get the best deal, best structure and best coverage,” Dollar said. “It’s crucial that credit unions do split-dollar right. But the benefits it brings when structured correctly make this a tremendous recruiting and retention tool at a time when the market for executive talent is very, very competitive.”
As CUToday.info has reported, collateral assignment split-dollar life insurance is used by many credit unions as a more affordable means of funding an executive’s supplemental retirement benefits. The arrangements, which are permitted under NCUA’s regulations and the regulations of nearly every state, provide credit unions with what Dollar said is a solid option to lock in talented executives in their final 10 to 15 years of their careers.
How Plans Work
With the employee named as the owner of the policy, a collateral assignment agreement representing a collateral security interest in the policy is executed for the benefit of the employer to secure repayment of the employer’s cumulative outlay. The credit union as employer advances money to the executive to cover the cost of the premiums.
Marla Aspinwall, a partner at Loeb & Loeb LLP, told CUToday.info in a prior report, “The loans may be provided on an interest-free basis or the arrangement may provide for the accrual of interest until the time the premiums are repaid. If the loan provides for interest at less than the applicable federal rate, the forgone interest is required to be imputed as income to the employee annually.
“Arrangements are often made in such cases to have the employer make an additional bonus payment to the employee to cover the cost of the taxes resulting from such imputation of income, at least during employment,” Aspinwall added.
Asspinwall further noted,“The arrangement generally provides that the employer will be repaid its cumulative premiums upon the death of the employee from the proceeds of the policy and any remaining proceeds will be paid to the employee’s named beneficiary. However, bonuses to cover tax liability are generally not recovered by the employer.”
Aspinwall explained that typically, during retirement, the employee is allowed to withdraw or borrow from cash values in excess of the amount pledged to the employer.
A Response to the Clamp Down
Also noting the shift to split-dollar from traditional deferred benefits programs started in earnest among CUs more than 10 years ago, Kirk Sherman, partner at Sherman & Patterson, Ltd., said many of the reasons for the change centered on the IRS “clamping down” on deferred compensation programs.
“These plans simply became less attractive and their ability to retain top talent was also diminishing,” Sherman explained.
What has now happened, Sherman told CUToday.info, is that many credit unions have put in place split-dollar plans they have given little thought to in the interim, resulting in potential problems such as under-performing economics, inadequate or unclear documentation, failure to file the required written representation, and poor recordkeeping.
So Many Plans, Questions
“There are so many of these plans out there, and so many different planners, that with economics changing, some of them are in jeopardy,” said Sherman. “For example, a prominent insurance carrier recently reduced what's called a cap rate. They have this wonderful policy that says we're going to protect the policy owner from the downside. They say we’re not going to charge the cash value when the rate of return is below 0%. But in exchange for that downside protection, we need to limit your upside opportunity.
Kirk Sherman
“So, if the policy produces more than the “cap,” we get to keep the excess,” Sherman continued. “If they invest and they produce 16%, and the cap is 12%, then the insurance company is 4% to the better. If they lower the cap, the insurance company keeps more of the upside and it becomes harder for the policy to produce the expected results.
“I don't know if the reductions are temporary, but that's one thing that's happening on these policies,” Sherman added. “That makes them so they may not be producing as well. And if they don't produce then the amount that the executive can borrow during his retirement is reduced.”
One Example of ‘Pressure’
While the pressure on the economics is a challenge, the administration can be an issue, as well, Sherman added.
“We had one example where a CEO was projected to be able to borrow, let's say $2 million, over the course of his retirement,” Sherman explained, “And, unbeknownst to everybody else, he borrowed the $2 million in a lump sum. So, that now has put a lot of pressure on that policy to be able to sustain and still produce the death benefit necessary to pay back the interest plus the credit union’s loan. Therefore, ongoing administration and oversight are critical.”
Taking a ‘Nosedive’
Sherman said there are “dials” within split-dollar policies that a credit union can turn over time that can help maintain policies to deliver the expected benefit.
“If the insurance agent sells a policy and then disappears after a year or two, nobody's paying attention. And over time these policies can nosedive—and then it's too late to adjust enough to recapture what has been lost,” Sherman said. “Administration with some providers has been lacking. That's the point that credit unions need to pay attention to. They must insist on whoever is administering the arrangement really pay attention to it.”
The other issue, Sherman said, is when it comes time for payments, or for the policy values to be divided, that's the wrong time to find out the documents are vague.
“Because then everybody's into an argument, particularly if it's a death benefit and the executive has died and the documents are vague about how the proceeds get split. That needs to evaluated regularly to make sure everybody understands the document—see how it's supposed to work,” he said.
What to Do
What should a credit union take care to do now?
“They need to make sure they understand where their arrangement is today, where the policies are, make sure they're compliant, and see how they're doing compared to original projections,” Sherman said. “If they're not meeting original projections, then find out why and what knobs and dials they can turn within the policy now to get closer to their objective.”
Sherman compared managing split-dollar policies to maintaining a car.
“They run wonderfully coming off the manufacturer’s floor, but if you never change the oil, if you never do the maintenance on it, then you get to a point where it breaks down. We're off path. How do we get back on? That means working closely with the engineers and technicians who really know their way around these arrangements,” he said.
Who Not to Ask
Sherman said the insurance company providing the policy is not the place to go for answers when it comes to adjusting the policy, should that be necessary.
“They will say, ‘We're meeting our contract. We can't tell you a lot about what you should or shouldn't do within the policy.’ But, they can give you what your options are,” explained Sherman. “It really takes an experienced insurance/compensation consultant, somebody who can see the big picture, understand the dials within the policy and start making recommendations.”
A Word for the ‘Wise’
What should a CU do today when looking for a new split-dollar policy?
“It would be wise to talk to multiple providers first, right out of the chute,” Sherman said. “Often, you will know someone who says I know someone, talk to my guy. Well, that person could lead you to a good plan, but the issue is that person does not have a broader view of what is out there regarding split-dollar. That’s just one option he is giving you. An experienced consultant has a broad view of what is available and can provide the best direction.
“Then can do a little comparative shopping, which is very wise. Test the assumptions in the policies,” continued Sherman. “The illustrations are critical and the interest rate and mortality charges assumed in those illustrations are the real keys. Are they realistic? Are you really going to be able to produce over time what the assumptions and illustrations are based on?”