Achieving your mission is not possible without the right leadership. You can lay out a compelling vision and foster a culture that encourages and motivates people to action. Culture alone, however, may not be enough. To attract – and keep – the highest performers you need to assemble a total compensation package that addresses both short-term and long-term needs for income.

Short-term compensation – the base salary and bonus – help fuel today’s lifestyle. It’s important to benchmark those regularly and there’s a best practice to doing that; that is a subject for another article.

Only relying on current cash compensation, however, is risky as there’s always a bigger checkbook elsewhere. Every employee, especially an executive, needs to plan for the day when current income ends (retirement). Including elements of long-term compensation helps then to both retain and reward your key people. These elements are generally referred to as executive benefits.

Only after you pinpoint the amount of an executive benefit should you then consider what form of benefit to provide. There are three general forms each with its own advantages and disadvantages. Here are examples of how three DCUC members deployed benefits that work for them.

Section 457(f). Based in the mid-Atlantic states, this credit union offers a 401(k) with match as well as a defined-benefit pension plan. Due to limitations on the amount of income that could be considered for qualified plan benefits nearly twenty of their top executives will not receive the intended benefits. The board wanted to offer benefits contingent on staying for the long-haul (much like the pension plan) and given the number of executives involved settled on a Section 457(f) plan.

With a 457(f) the credit union makes a “mere promise” to pay a benefit in the future. No specific asset needs to be purchased. The credit union accrues the future benefit liability by expensing the cost. Benefits will be paid from general assets. The executives must stay until the payment date – voluntarily leaving before results in forfeiture of unpaid benefits. Upon vesting the executive must pay ordinary income taxes on the amount. Under the Tax Cuts and Jobs Act of 2017, if the total compensation (base, bonus, 457(f)) paid to any executive exceeds $1 million in a year the credit union will be subject to an excise tax (currently 21%) on the amount that exceeds $1 million.

Restricted Executive Bonus Agreement (REBA). Based in the central US, this successful credit union is rapidly growing and needs to retain seasoned executives as well as recruit additional talent. While they could readily absorb the expense of a 457(f), the board wanted a plan that offered better income-tax treatment than a 457(f) yet still had some handcuffs.

Enter a Restricted Executive Bonus Agreement or REBA, which requires the executive to purchase and own a life insurance policy. Life insurance gets special treatment: values grow tax-deferred, distributions can be income-tax-free, and death benefits are income-tax-free. The funding is limited only by the insurance company’s underwriting risk tolerance.

Under a REBA the credit union agrees to pay the premiums if the executive remains employed. Each premium payment is a current expense so there is no liability to accrue, and each payment is current ordinary income to the executive. The policy has a restrictive endorsement that prevents the executive from taking distributions too soon. While the executive can be vested in the cash value, certain terminations can cause forfeiture of the policy (thereby providing handcuffs for the credit union). The total cost to provide a REBA with tax-equivalent benefits is 25%-30% less than a 457(f).

Split-Dollar Loan (SDL). Based in the Midwest, this credit union has received several awards for performance and providing member value. The board wanted to recognize senior executives for leading the charge. There was an established 457(f) plan for one of them; while the executive was satisfied with the lump sum payout despite the large income-tax, the excise penalty under TCJA 2017 forced another look at the plan. After a months-long evaluation, the board decided to modify the 457(f) and implement a Split-Dollar Loan or SDL arrangement for the executives.

Like a REBA, SDL requires the executive to purchase and own a life insurance policy. However, the premiums paid by the credit union are treated as a loan to the executive. The typical design has the credit union advancing 7-10 years of premiums in the first year, meaning the funding required can be significant relative to net worth. The credit union will recover the premiums with interest no later than death. To secure recovery, the credit union takes a collateral assignment in the policy.

Split-Dollar Loan is more complicated than either a 457(f) or a REBA, however, the total cost to provide a SDL is ultimately zero given the built-in recovery. It’s critical that the board understand that the collateral value may be less than the outstanding loan balance (especially in the early years); how that difference is treated may impact the credit union’s financials.

Each client was able to solve their primary objective – helping to attract, retain, and reward the right leadership. The difference was in the approach – each evaluated each form and chose what checked the most boxes for them (and their executives).

Recession Outlook Summary

• Our Recession Probability Model rose across all horizons in the first quarter of 2019. While near-term recession probability is limited, the probability of a recession occurring over the next 24 months has more than doubled.
• The deterioration in leading indicators, inversion of the yield curve, and tightening of monetary policy all contribute to rising recession risks. As we expect these trends to continue in 2019, we should see recession risk rise throughout the year.
  
• We maintain our view that the recession could begin as early as the first half of 2020, but will be watching for signs that the dovish pivot by the Federal Reserve (Fed) could extend the cycle.
• The next recession will not be as severe as the last one, but it could be more prolonged than usual because policymakers at home and abroad have limited tools to fight the downturn.
• Credit markets are likely to be hit harder than usual in the recession. This stems from the record high ratio of corporate debt to GDP and the likelihood of a massive fallen angel wave.
• When recessions hit, the magnitude of the associated bear market in stocks is driven by how high valuations were in the preceding bull market. Given that valuations reached elevated levels in this cycle, we expect a severe bear market of 40–50 percent in the next recession.
  

Recession Expectations Go Mainstream

Important Notices and Disclosures

Investing involves risk, including the possible loss of principal. This material is distributed for informational or educational purposes only and should not be considered a recommendation of any particular security, strategy or investment product, or as investing advice of any kind. This article is not provided in a fiduciary capacity, may not be relied upon for or in connection with the making of investment decisions, and does not constitute a solicitation of an offer to buy or sell securities. The content contained herein is not intended to be and should not be construed as legal or tax advice and/or a legal opinion. Always consult a financial, tax and/or legal professional regarding your specific situation.

This material contains opinions of the author but not necessarily those of Guggenheim Partners or its subsidiaries. The author’s opinions are subject to change without notice. Forward looking statements, estimates, and certain information contained herein are based upon proprietary and non-proprietary research and other sources. Information contained herein has been obtained from sources believed to be reliable, but are not assured as to accuracy. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Guggenheim Partners, LLC. Past performance is not indicative of future results. There is neither representation nor warranty as to the current accuracy of, nor liability for, decisions based on such information.
Guggenheim Investments represents the following affiliated investment management businesses of Guggenheim Partners, LLC: Guggenheim Partners Investment Management, LLC, Security Investors, LLC, Guggenheim Funds Investment Advisors, LLC, Guggenheim Funds Distributors, LLC, GS GAMMA Advisors, LLC, Guggenheim Partners Europe Limited and Guggenheim Partners India Management.

© 2019 Guggenheim Partners, LLC. All rights reserved. Guggenheim, Guggenheim Partners and Innovative Solutions. Enduring Values. are registered trademarks of Guggenheim Capital, LLC.

IZALE Financial Group is hereby authorized to use the copyrighted report “Forecasting the Next Recession: How Severe Will the Next Recession Be?” by Guggenheim Partners, solely for the purpose of posting on its company blog, found here.

Consult with a professional advisor about your particular situation.

Are insurance benefits provided to board members considered taxable income? The answer is largely “yes,” but also, “it depends.”

“The general rule under the tax code is something provided in return for services rendered is taxable income to the recipient (board member),” says R. Scott Richardson, JD, CLU, ChFC, president/CEO, IZALE Financial Group, a CUES Supplier member in Elgin, Illinois. “However, insurance benefits can be treated differently.”

Richardson explains that while the value of accident and health insurance is not taxable for employees, it will likely be taxable for board members. 

“There are narrow exceptions where it would not be taxable income,” so consulting a tax advisor is worthwhile, he says.

In the case of life insurance, rather than take out a formal policy, credit unions can promise to pay a benefit (out of pocket) upon a board member’s death, in which case the beneficiaries would report the amount as ordinary income. The CU is essentially acting as its own insurance.

However, in the event of a policy paid for by the CU, Richardson reports there is a choice: “Either the board member reports the ‘economic benefit’ of the coverage as income each year, resulting in an income-tax-free benefit, or the board member does not report economic benefit, resulting in a benefit subject to ordinary income taxes.”

Life insurance is generally income-tax free except when someone else pays for it, in which case there’s some “economic benefit” to the board member, he explains. If the board member owns the policy but premiums are paid by the CU, the premiums paid by the CU equal the economic benefit and are taxable income. If the CU owns the policy and allows the board member to designate a beneficiary, then the right to designate the beneficiary is the economic benefit. If the board member reports the value of that economic benefit each year as taxable income, then death proceeds received would be income-tax free. If the board member does not report the value of the economic benefit each year, then death proceeds would be subject to ordinary income tax.
With long-term care insurance, Richardson notes that any benefits received under a qualified policy are not taxable, though the premiums likely would be. “Since board members are not employees, they would be treated as ‘self-employed’ for income-tax purposes.”

Jim Patterson, partner with Minneapolis-based law firm Sherman & Patterson, similarly notes that directors are under different tax rules than employees. “… directors are not subject to some of the tax benefits that employees get,” he said. “In the case of long-term care insurance, for instance, if that were provided to an executive employee of the credit union, it can be done so on a tax-free basis. But for directors, who are not employees, that would be considered taxable income.”

Even if these benefits are taxable, Richardson says there are still advantages for both the board member and the credit union. “First, paying taxes on $1 of reportable income requires much less cash flow than paying the $1 of premium out of pocket. Second, there are pricing discounts and underwriting concessions available to groups that can be the difference between being affordable and attainable versus not.”

Richardson concludes with advice to consult with tax professionals “to understand the full implications.”

Diane Franklin is a freelance writer based in Missouri. This article published with expressed permission from CUES