Insights
Occasional papers from Western CUNA Management School

Some credit union boards provide additional taxable income to their executives through higher than typical salary and bonus to "make up" for the limitations on qualified retirement plans available to their executives. This approach is simple and relatively easy to administer and it assists in recruiting and rewarding executives. However, there is no deferral of taxes for the executive and the credit union does not have the advantage of deferred "vesting" to encourage continued service by the executive (retention).

An increasingly popular area of recruiting, rewarding and, in some cases, retaining executives is through the use of "nonqualified" plans such as deferred compensation plans. Such nonqualified plans allow executives the advantage of deferral of taxes on certain compensation and allow for an opportunity to provide the executive with retirement savings that could not be provided to him or her in a qualified plan.

Another advantage of nonqualified plans is that they avoid most of the provisions of Employee Retirement Income Security Act (ERISA) so long as the plans are only for the "Top Hat" employees (that is, typically, the best paid and most senior employees of the organization). In this respect, a credit union can provide for nonqualified retirement benefits for one or a few senior executives which would otherwise be too expensive to provide the entire employee population if similar benefits were provided under a qualified plan.

So What Nonqualified Plans Are Available to Credit Unions and their Executives?

While there are many types of nonqualified plans that are available to credit union executives, the three most typical are 457(b) plans, 457(f) plans and Section 83 "option" plans. A number of credit union executives are also involved with "split dollar" life insurance plans. In brief, 457(b) and 457(f) plans are plans contemplating deferral of taxable income to a future date. "Option" plans contemplate a transfer of property to an employee at a future date without creating immediate taxation to an employee and "split dollar" plans contemplate insurance for an executive's beneficiaries paid for by the credit union. Each of these plans is discussed in greater detail below. Keep in mind that the requirements for each plan are technical and rather complicated. However, it is useful to explore the "basics" here.

457(b) Deferred Compensation Plans

457(b) plans have long been available to credit unions as a means of allowing their executives to defer taxation of some of their base salary to a future date. Since 1996 these types of plans have been unpopular as the amount of income that could be deferred was limited by contributions to a credit union's qualified 401(k) plan. Given the greater protections of the qualified 401(k) plans, the use of the 457(b) plan by credit union executives fell into disfavor. However, beginning in 2002, Top Hat executives can reduce their current taxable income through contributions to a 457(b) plan without regard to contributions to their credit union's 401(k) qualified plan. The contribution limits for a 457(b) plan is currently $11,000 and increases by $1,000 per year until $15,000 in 2006.

The advantage of the 457(b) plan is that it provides additional opportunities for tax deferred growth for credit union executives, and the executive can elect for an "annuitized" payout of benefits under the plan over a period following the executive's retirement with taxation of the benefits only in the year received. Also, such plans are relatively low cost to credit unions as a number of providers offer "turn key" 457(b) plans to credit unions.

A perceived disadvantage for executives is that 457(b) plans are "unfunded". That is, the plan participants are merely general unsecured creditors of the employer in the event of the credit union's insolvency or liquidation. However, this is also true of 457(f) deferred compensation plans and Section 83 "option" plans; otherwise if any of such plans were to be truly "funded," with separately held assets held in trust, the plan would be subject to the rules applicable to qualified plans under ERISA. In that event, the plan benefits would necessarily have to be provided to all credit union employees, not just the Top Hat employees. Keep in mind, however, that federally insured credit unions in danger of insolvency or liquidation are subject to severe limitations on compensation arrangements. As a practical matter, then, nonqualified plans are typically entered into only by "healthy" credit unions such that credit union executives generally are not greatly concerned by the "unfunded" nature of such plans.

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