The consolidation of credit unions poses a risk to all forms of retirement benefits provided to the executives of organizations that are merger targets.
Sponsored by BenefisCU, powered by TriscendNP
Over the last decade, credit unions have been consolidating rapidly. With the resulting increase in total asset size per credit union, the surviving credit unions are becoming more sophisticated organizations out of necessity. According to the NCUA, 41 mergers were approved in Q1 of 2022, which is on pace with 2021.
Using supplemental executive benefits (SERP) is a common way for smaller credit unions (who are frequently targeted for mergers) to attract, retain and reward senior management talent. In credit unions, like all tax-exempt organizations, these plans take on or more of the following three forms, each with at least one variation:
- Deferred Compensation Arrangements;
- Executive Bonus Plans; and
- Split-Dollar Arrangements.
The pattern of consolidation experienced in the industry can put these existing plans, and the benefits executives hope to receive, at risk if the target credit union merges into a larger organization. In this article, we will briefly describe each plan type, explore the potential risks present in a change of control scenario, and offer possible solutions to help the credit union protect the interests of its executives.
Deferred Compensation Arrangements, sometimes referred to as §457(f) plans, are a promise made by an employer to pay an amount of money to an executive in the future. This promise to pay must be subject to a risk of forfeiture to avoid inclusion in the executive’s income. There are conditions that constitute a risk of forfeiture, and once said conditions no longer exist (vesting, for example), all or a portion of the amount to be paid is subject to income tax. Examples of risks of forfeiture include:
- the requirement to remain employed to a specific date;
- achievement of performance objectives; and
- employer fails to remain a going concern.
Because these plans are only unsecured promises, the acquiring credit union’s leadership could renege on the unvested/unpaid portion of that promise at any time. As a result, credit unions and executives must be diligent in documenting the arrangement such that, if desired, an executive is protected if there is a change in control.
Executive Bonus Plans provide for periodic payments (usually annually) made to an executive should they remain employed for the applicable period. The payments are not made in cash directly to the executive. Instead, they are paid to a permanent life insurance policy. The executive owns the policy, and it is usually designed to accumulate cash value to supplement an executive’s retirement cash flow. Compensatory in nature, each premium payment is considered taxable income to the executive and a compensation expense to the employer. Unlike deferred compensation, there is no extended deferral period, and, once paid, these premiums are not subject to a risk of forfeiture.
Like Deferred Compensation Arrangements, an acquiring credit union could elect to terminate the arrangement and cease future premium payments into the life insurance policy. While these consequences are not as dire as reneging on a deferred compensation payment, depending upon the timing, ceasing future premiums could result in the policy lapsing in the future. A lapse of the policy would result in a complete retirement benefit loss.
Split-Dollar Arrangements are the fastest-growing supplemental executive retirement benefit plan alternative being implemented in credit unions nationally. Split-dollar arrangements, of which the collateral assignment (or loan regime) is the most prevalent, involve the employer’s payment of premiums to one or more life insurance policies. While these arrangements are typically funded entirely at implementation, they are occasionally funded over five or seven years.
Non-compensatory in nature, the premiums paid by the employer are treated as loans from the employer to the executive for tax purposes only and do not result in taxable income so long as sufficient interest is paid. The executive owns the policy(ies) and, subject to the terms of the Split-Dollar Agreement, e.g., vesting, etc., can access a portion of the policy’s cash value for retirement or other future purposes.
By their very nature, Split-Dollar plans can provide more security to an executive than other plans. Except for future premiums and the potential for non-vested termination, an acquiring credit union can only assume the rights and responsibilities of the target credit union and be subject to the terms of the Split-Dollar Agreement as is. The arrangements on which BenefisCU powered by TriscendNP assists its clients require mutual agreement (including executive consent) to effect a change in the agreement.
Unlike deferred compensation plans, vesting and taxation are decoupled, which means executives can vest incrementally in the benefits over time without incurring taxation. This incremental vesting also lowers the plan’s change in control risk. That said, potential adverse outcomes are possible if not adequately addressed in the Split-Dollar Agreement. Examples include:
- Assuming the split-dollar arrangement is implemented utilizing a multi-year fund, as opposed to funding at implementation, there is a risk that future premiums are not paid, which could place the policy(ies) at risk of lapse. There are associated tax risks if this occurs; and
- Termination of the executive without any vesting would result in complete forfeiture of the split-dollar benefit.
The consolidation of credit unions poses a risk to all forms of retirement benefits provided to the executives of organizations that are merger targets. However, proactive thinking and careful planning can mitigate and even eliminate these risks, allowing credit unions to focus on retaining its executive talent. Additionally, should a merger occur, this same approach can ensure a smooth transition into a larger organization.
Addressing the potential risks that exist between plan types have some similarities, for which we offer possible solutions below:
- Include provisions in the plan agreement(s) to accommodate for voluntary termination for Good Reason and a Change of Control event. These provisions can be structured to provide for full or partial vesting depending upon the desires of the credit union and the executive.
- Institute shorter-term vesting events. For deferred compensation arrangements, the tradeoff is that taxation will occur at each vesting event. However, this approach would mitigate the executive’s risk of complete benefit loss.
- For a split-dollar arrangement, fully funding the policy(ies) at implementation lowers change in control risk, as well as providing additional benefits to both the employer and the executive.
- Ensure each agreement requires the employer and executive mutual agreement to terminate or amend.
About BenefisCU powered by TriscendNP
BenefisCU, powered by TriscendNP, provides turnkey, advanced insurance solutions to credit unions and their members. A CUSO opportunity offered by TriscendNP, Goldenwest Credit Union, Dollar Associates, LLC, and seven other industry-leading credit unions, BenefisCU seeks to provide a way for credit unions to capture revenue that has been captured by publicly traded, for-profit consulting firms. Utilizing advanced insurance offerings such as Executive Benefits and Credit Union Owned Life Insurance, BenefisCU is breaking the mold with new and inventive ways to supplement traditional growth strategies and increase credit unions’ return on assets (ROA).
H. David Wright is a co-founder and serves as chief strategy officer at TriscendNP with primary responsibility for strategy and business development and has served in this capacity for 20 years. Areas of expertise include business development, compliance, business transactions, and financial and accounting topics.