Recently, there have been articles in the media that talk about a purportedly "new" and "secure" way to deliver tax free executive retirement income and a tax free death benefit. This supposedly superior solution to credit union executive retirement needs suggest that everybody wins. However, the old adage "If it looks too good to be true, it probably is" holds here. These kinds of programs are neither new nor secure and require a closer look.
These programs are essentially collateral assignment split-dollar plans. The mechanics appear to be relatively straight-forward. A life insurance policy is purchased, with the executive as the owner of the life insurance contract. The credit union makes a loan or loans to the executive to pay the premiums. The executive assigns a portion of the policy cash value and/or death benefit to the credit union to pay back the cumulative premiums loaned by the credit union. Loans may be repaid either at retirement, at death or some combination of both.
The structure of CASD requires that the arrangement be in place for a very long time in order to deliver the expected benefits. It is important that credit union boards look at all of the what-ifs. A CASD proposal can be manipulated to represent very favorable–and sometimes unrealistic–results by utilizing aggressive dividend or earnings assumptions. The cash value ultimately available for retirement benefits via policy loans and withdrawals will be based on the actual policy performance over time, not on the initial assumptions.
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The long-term performance of the insurance contract can be difficult to accurately project, and actual results that do not keep pace with assumptions result in lower than expected retirement benefits or a policy lapse, in which case the executive ends up without the expected post-retirement income and death benefit.
IRS treatment of CASD policies further complicates the purported simplicity of the arrangement. Premium payments become real loans, subject to loan interest at a market rate. There is the risk to the executive if the IRS deems the life insurance policy to be insufficient collateral to satisfy the debt. Under IRS regulations, taxes and penalties can result if there is not a reasonable expectation that the credit union will be repaid the full amount of premiums (loans) based on the "collateral" (cash value in the policy). If the loan is deemed forgiven, the entire amount of the loan is taxable to the borrower (executive).
Another significant risk of CASD relates to the impact of an early termination of the arrangement. Cash values in a typical CASD arrangement rarely exceed cumulative premiums until the policy has been in force for 10 or more years. In the event of a termination of the insurance contract in the early years, the credit union may be forced to forgive the cumulative premium loan or to take ownership of the policy if cash values are not adequate for full repayment of the loan. In these events, the full amount of any forgiven loan is immediate taxable income to the executive–with nothing to show for it. This makes it very difficult to terminate CASD arrangements during the early years without significant tax liability to the executive and a corresponding loss to the credit union of the amount of the unpaid loan.
Beyond the above considerations, it is imperative that credit unions contemplate the accounting impact of any CASD arrangement that is intended to continue into the executive's retirement. FASB accounting standards describe a liability to the employer if it "has agreed to maintain a life insurance policy during the employee's retirement or provide the employee with a death benefit based on substantive agreement with the employee." If the credit union has a stated or implied commitment to continue to provide loans to an executive to cover premium payments after the executive is no longer employed by the credit union, the credit union must recognize the estimated cost of maintaining the insurance policy into the executive's retirement as a current liability.
One must question why CASD is rarely used in other economic sectors, but widely promoted in the credit union movement. The bottom line is that a once prevalent tool has significant risk factors that are not being appropriately considered by credit union decision makers, perhaps because they are not adequately disclosed. Proceed with caution and be aware of all potential scenarios before moving forward to implement a collateral assignment split-dollar arrangement.
Suzanne Meyer is technical adviser at Executive Compensation Solutions.
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