Insights
Occasional papers from Western CUNA Management School

Even so, the IRS has been closely scrutinizing such plans in recent years and the law in this area is in a state of flux. For example, a recent IRS Notice indicates, and very recent proposed IRS regulations suggest, new guidance as to how to treat such arrangements for tax purposes. At the risk of oversimplification, split dollar life insurance arrangements are to be characterized pursuant to one of two mutually exclusive approaches. Under the first approach, the economic benefit of a split dollar life insurance is generally treated as a transfer to a benefited party (that is, the employee is not taxed until the benefit, such as the cash surrender value, is transferred to the employee). Under the second approach, premium payments by the employer pursuant to a split dollar arrangement are generally treated as a series of loans to the executive (that is, there is imputed income to the executive since the "0% loans" are "below market" loans). It is our observation that the complexity of the law in this area and the state of flux in the law has had a "chilling effect" on the continued use of split dollar life insurance plans by credit unions.

NCUA Requirements for Retirement Benefits

When a board reviews an executive's compensation package, it should consider federal and state law to assure itself that the package is compliant and in the best interests of the member owners of the credit union. NCUA Regulation Section 701.19(a) indicates that a federal credit union may provide "reasonable" retirement benefits for its employees. NCUA in a recent proposed Rule has signaled that the scope of Section 701.19(a) extends not only to retirement benefits but also to other employee benefit plans.

Under this analysis, a board must consider the "safety and soundness" of the executive's compensation package, it must determine that the compensation package is legally compliant and it must determine whether any investments made by the credit union to pay for the executive's benefits are permissible.

Safety and Soundness

The expression "safety and soundness" is of course a "catch all" phrase that encompasses a wide variety of issues. Pursuant thereto, among other things, the board must determine whether the credit union has the financial ability to fund the annual costs of the executive's benefit plan and the administrative costs associated therewith. Financial wherewithal, of course, requires the board to exercise its business acumen in conjunction with input from management staff, outside accountants and outside professional financial advisors.

The board will also need to review whether the benefits to an executive under a benefit plan constitute reasonable compensation for services. That is, are the benefits to the executive in proportion to the benefits received by the credit union providing the plan to its executive? What would be the effect on the credit union if it did not provide the benefit plan? "Reasonableness of compensation" is discussed in further detail below.

NCUA regulations also require a federal credit union, when acting as a "fiduciary" (a term defined by ERISA) to obtain fiduciary liability coverage. The board will need to review whether it is a "fiduciary" under a nonqualified plan with legal counsel. Also, the issue and the extent of fiduciary liability coverage should be reviewed with the credit union's insurance carrier.

Legal Compliance

The board will want to assure itself that the plan document and its administration are compliant with federal and state law. This typically suggests the need for reliance upon attorneys, accountants and compensation consultants familiar with the area. 3 The board members must not have a conflict of interest and the board must conduct due diligence in reviewing the competency and advice of such consultants and assure itself that the advisors are in fact working for the credit union (and not the executive). In such event, the board is generally entitled to rely on the advice and counsel of its attorneys, accountants and consultants.

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³For example, while "Top Hat" non-qualified plans are exempt from most of ERISA's provisions, the employer is still subject to a procedural requirements such as a claims procedure, the need for a notice to be filed with the Department of Labor within 120 days of the date of the plan, a prohibition upon "formally" funding the plan, and as noted above, the need for fiduciary liability coverage.