Same Long-Term Goal, But Different Choice Of Executive Benefits Plans

1: Chose 457(f) Plan to Help Retain Many Executives

This billion-dollar-plus credit union offers a 401(k) with a match as well as a defined-benefit pension plan. Due to limitations on the amount of income that could be considered for qualified plan benefits, almost 20 of their top executives will not receive the intended benefits.

The board wanted to offer benefits contingent on staying for the long haul (much like the pension plan) and, given the number of executives involved, settled on a Section 457(f) plan. With a 457(f) the credit union makes a “mere promise” to pay a benefit in the future. No specific asset needs to be purchased.

The credit accrues the future benefit liability by expensing the cost. Benefits will be paid from general assets. The executives must stay until the payment date; voluntarily leaving before that date results in forfeiture of unpaid benefits.

Upon vesting, the executive must pay ordinary income taxes on the amount. Under the Tax Cuts and Jobs Act of 2017, if the total compensation (base, bonus, 457(f)) paid to any executive exceeds $1 million in a year, the credit union will be subject to an excise tax (currently 21%) on the amount that exceeds $1 million.

2: Chose a REBA for Its Tax Benefits

This multi-billion-dollar credit union is rapidly growing and needs to retain seasoned executives as well as recruit additional talent. While it could readily absorb the expense of a 457(f), the board wanted a plan that offered better income-tax treatment than a 457(f) yet still had some handcuffs.

Enter a Restricted Executive Bonus Agreement or REBA, which requires the executive to purchase and own a life insurance policy. Life insurance gets special treatment: values grow tax-deferred, distributions can be income-tax-free, and death benefits are income-tax-free.

The funding is limited only by the insurance company’s underwriting risk tolerance. Under a REBA, a credit union agrees to pay the premiums if the executive remains employed. Each premium payment is a current expense so there is no liability to accrue, and each payment is current ordinary income to the executive.

The policy has a restrictive endorsement that prevents the executive from taking distributions too soon. While the executive can be vested in the cash value, certain terminations can cause forfeiture of the policy (thereby providing handcuffs for the credit union). The total cost to provide a REBA with tax-equivalent benefits is generally less than a 457(f).

3: Chose an SDL Plan to Manage the Excise Penalty

This billion-dollar-plus credit union has received several awards for performance and providing member value. The board wanted to recognize senior executives for leading the charge.

There was an established 457(f) plan for one of them; while the executive was satisfied with the lump sum payout despite the large income tax, the excise penalty under the Tax Cuts and Jobs Act forced the board to take another look at the plan.

After a months-long evaluation, the board decided to modify the 457(f) and implement a split-dollar loan arrangement for the executives. Like a REBA, an SDL plan requires the executive to purchase and own a life insurance policy.

However, the premiums paid by the credit union are treated as a loan to the executive. The typical design has the credit union advancing seven years of premiums in the first year. The credit union will recover the premiums with interest no later than death. To secure recovery, the credit union takes a collateral assignment in the policy.

An SDL plan is more complicated than either a 457(f) or a REBA, however, the total cost to provide an SDL is ultimately zero, given the built-in recovery. The board must understand that the collateral value may be less than the outstanding loan balance (especially in the early years); how that difference is treated may impact the credit union’s financials.