Collateral assignment split dollar: The good, the bad, and the ugly

In the realm of executive compensation and employee benefits, collateral assignment split dollar arrangements have emerged as a popular strategy for credit unions seeking to provide valuable perks to key executives while keeping retention goals in mind. While these arrangements offer potential benefits, they also come with complexities and considerations that credit unions must carefully navigate.

Understanding collateral assignment split dollar

Collateral Assignment Split Dollar (CASD) is a compensation and retention arrangement wherein a credit union provides a life insurance policy(ies) to a key executive or employee. Under the CASD arrangement, the employer advances funds to the employee to pay the policy(ies) premiums. These advances are structured as loans, collaterally secured by the cash value and death benefit of the life insurance policy(ies).

The essence of this particular split dollar structure lies in the collateralization of the policy’s benefits; hence the name collateral assigned split dollar. The credit union retains an interest in the policy as collateral for the loan advanced to the employee. In the event of the employee’s death for example, the credit union’s loan is repaid from the policy’s death benefit, with any remaining proceeds typically going to the employee’s beneficiaries.

The good: Benefits for credit unions

Collateral assignment split dollar arrangements offer several potential advantages for credit unions:

1. Executive attraction and retention: By offering split dollar as part of an executive compensation package, credit unions can attract and retain top talent. This arrangement provides executives with valuable benefits, including potential tax advantages associated with life insurance and retirement income, which can serve as a powerful incentive for long-term commitment.

2. Customization and flexibility: Collateral assignment split dollar arrangements can be tailored to meet the specific vesting needs of the credit union and cash flow needs of the executive. This flexibility allows for the customization of benefits, premium payment schedules, and other terms to align with the credit union’s strategic goals and the executive’s financial circumstances.

3. Risk mitigation: By collateralizing the loan with the life insurance policy, credit unions can mitigate the risk of default. In the event of the employee’s death, the credit union’s loan is secured by the policy’s death benefit, reducing the credit risk associated with the arrangement. The CASD arrangement can also serve as key person coverage at no additional cost to the sponsoring credit union.

The bad: Potential drawbacks and considerations

Despite their advantages, these arrangements also present certain challenges for credit unions:

1. Complexity and administration: Implementing and administering a collateral assignment split dollar arrangement can be complex and requires active management for the life of the plan. Credit unions must navigate various legal, accounting, and tax considerations to ensure proper structuring and execution.

2. Regulatory compliance: Collateral assignment split dollar arrangements are regulated by the NCUA, particularly regarding concentration risk and accounting rules. Credit unions must ensure compliance with applicable regulations and seek expert guidance to avoid potential issues or adverse consequences.

3. Tax implications: The tax treatment of these arrangements can be complex and may vary depending on the specific structure and circumstances. Credit unions and executives should consult with tax experts to understand the tax implications of their CASD plan.

The ugly: Pitfalls to avoid

Credit unions must be mindful of potential pitfalls associated with collateral assignment split dollar arrangements:

1. Communication and transparency: Clear communication and transparency are essential for the success of these plans. Credit unions must ensure that executives fully understand the terms, risks, and obligations associated with the arrangement to prevent misunderstandings or disputes.

2. Exploring alternatives: Split dollar arrangements are just one option for providing executive benefits. Credit unions should carefully evaluate exit options for their CASD plans, alternative compensation and benefit strategies to determine the most suitable approach based on their specific needs and objectives.

3. Seeking professional guidance: Given the complexities involved, credit unions should seek guidance from experienced professionals, including legal advisors, tax experts, and financial consultants, when considering and implementing CASD arrangements.

Conclusion

Collateral assignment split dollar plans can be an effective tool for credit unions to provide attractive executive benefits and incentives. However, they require careful planning, implementation, and ongoing management to maximize their benefits and mitigate risks. By understanding the good, the bad, and the ugly aspects, credit unions can make informed decisions and leverage these arrangements to achieve their strategic objectives.