As not-for-profits, credit unions are limited in what they can do to recruit and retain top talent, particularly since the excise tax was implemented. All of those 457(f) plans tied to the stock market are getting costly for both the credit union and your valuable executives. They’re taking significant losses right now during the coronavirus pandemic and likely would any bear market.
Executives and their boards should be investigating split-dollar, whole life SERPs, which are very viable options. Immediately turn a 457(f) liability – especially during this time of lost income – into a performing asset with a split-dollar plan. These SERPs are based on a life insurance policy the credit union executive owns, but the credit union has a lien against it, just like a mortgage. From the first premium payment, the credit union accrues interest on the retirement pay outs borrowed against it. Plus, split-dollar SERPs experience significantly less volatility and more consistent returns. In fact, the cash value is guaranteed to increase every year when funded with whole life insurance policies.
Every SERP is customizable to the board and executive’s risk tolerances. We generally don’t write Split-Dollar SERPs with Indexed Universal Life (IUL) insurance because of the volatility in these plans. They are expected to lose money about half the time when taking into account the bear market years, so we tend stay away from them except for death benefits.
While the current environment is negatively affecting all retirement plans whole life SERPS are only experiencing downward pressure on the dividend. IULs have even greater downward pressure because caps are continually reduced, lowering the potential return, plus the market volatility, especially as distributions are paid out. Insurance companies even recommend using 70% of the maximum illustration rate on IULs when setting plans rather than the full illustration rate.
In comparison, think about the 457(f): It’s essentially a bonus based on time the executive is paid at intervals or retirement. The credit union is accruing an expense and the payout is then treated as ordinary income on the executive’s W2, which means the executive is paying federal, state, and local taxes, plus the bottomless Medicare tax. In the worst-case scenario, between the 21% excise tax and federal and state income tax, the credit union could pay out $1.21 M to get the executive $500,000 in their pocket. As much as credit unions lobby to maintain their federal tax exemption, with a 457(f), the credit union is making a conscious decision to pay taxes.
Split-dollar SERPs, on the other hand, accrue interest income from the inception of the loan; that’s why OM Financial brought the concept to the NCUA and was the first company to receive the agency’s approval for these programs. The annual payments received by the executive in retirement are not taxable. And, when the executive passes away, the death benefit is divided between the credit union and the executive’s estate – tax free! The credit union is made whole by the insurance company on its principal and interest, and the executive’s family is taken care of as well. Particularly, if the executive passes away unexpectedly early, the total benefit to their family is even more substantial.
I don’t want split-dollar accounts to seem too good to be true; there are some downsides. First, the 457(f) concludes at a finite time, while a split-dollar SERP is indeterminate because it’s based on the time of the executive’s death, so it’s considered a long-term asset. The other potential negative is when the policy is taken out, the interest rate is locked in, and both the credit union and executive would have to agree to change the terms if the other party requested.
Boards should consider the split-dollar program is also superior as a retention tool. With a 457(f), the executive is 0% vested until they’re 100% vested, but using a split-dollar SERP, boards have more flexibility to build a custom vesting schedule for each executive. Recruiting executives away from solid credit unions with strong, attractive SERPs is incredibly difficult. Don’t let someone else steal your leadership with a better deal.
When converting from a 457(f) plan to a split-dollar SERP (OM Financial will even run a free stress test on your current plans), the credit union immediately turns a liability into a performing asset, something credit unions can definitely use right now while income is down due to coronavirus. Split-dollar plans help credit union boards recruit and retain talented leadership and earn additional income, while executives and their families are also covered. A split-dollar, whole-life SERP is something for boards and executives to consider as we all move forward during this time of uncertainty.
“Times, they are a-changin’.”
Before long, most readers of this publication won’t get that reference to the great Bob Dylan song.
Fully half of baby boomers will turn 65 in the next 10 years and like the definition of classic rock, it will impact the credit union community tremendously in terms of retirements and their replacements.
The coronavirus pandemic is highly likely to accelerate the process. Consider the stress on a cooperative financial institution and its leadership when dealing with the relatively sudden economic crisis. In addition, the need for digital transformation has only become a greater imperative for continued member service. And on the flip side of that, is the transformation of the traditional retail business model. Regulatory pressures are mounting. That means alterations to management style and business model, quick and consistent learning curves and just change.
Half of CEOs plan to transition – whether retire or change positions – in the next six years. And it’s not just CEOs, but the entire C-suite that will be affected. If your credit union is not prepared with a succession plan, the transition will not go smoothly and it can take years, literally, for the credit union to recover. No credit union can afford that.
We are having to become more agile and very tech focused right now. That will require a very different skill set than when most credit union boards hired their last CEO, possibly decades prior. Fintechs have also invaded credit unions’ battle ground in the war for talent. Their products are innovative and exciting, which can be very attractive for a young executive and their pockets may be deeper, too. Ensuring your credit union has a competitive compensation and benefits plan – not just competitive for the credit union market, but for others who are trying to recruit the same talented executives – is critical.
Understanding the need for the type of leader your credit union will require is crucial and necessitates a clear understanding of the current strategy, as well as, what the credit union may look like five to ten years out. If your credit union is $100 million in assets right now and it’s expected to reach $400 million in assets in the next 10 years, that alone will require a different organizational structure, diversification of products and services and potentially charter or field of membership changes. Each of these pieces fall together to complete a framework for your next CEO candidate.
Include your credit union’s current CEO in these discussions, too. They are experts in financial services, in your market and particularly internally regarding your credit union.
Despite the stiff competition in the talent pool and a broad understanding of what’s in store for the future of financial institutions, only 68% of credit unions have succession plans in place. To maintain a thriving credit union, ensure your board is preparing for the future by:
Supplemental Executive Retirement Plans are important for not just recruiting but retaining high-quality leadership. Ensuring it aligns to the board’s vision for the credit union can be complicated, so it’s a good idea to retain outside experts. Many credit unions have long-time CEOs, and executive compensation plans have changed tremendously since the last time the board may have studied the issue.
In fact, we recommend credit unions treat their succession planning almost like strategic planning; it should be performed annually to stay on top of the issues of the day and your internal candidates’ progress. Are they filling skill gaps with education and training? How are they leading their current area of responsibility? How do they manage the politics of the organization? Review their strengths and weaknesses with brutal honesty. It’s a multi-year process to develop a real understanding of an internal candidate’s potential. Rigor matters.
Finding your credit union’s next CEO is the biggest decision the board can make and the succession plan must be carefully put in motion as early in advance as possible to ensure a smooth transition that keeps the credit union moving forward. And within that process there are a hundred other important decisions to make, from capabilities of the candidates to how they’ll be compensated. Prepare so your credit union doesn’t let your top talent go – like a rolling stone.