Split-dollar loan (SDL) remains a popular form of executive benefit, driven by more favorable financial impact on the CU vs. other benefit forms as well as the potential for income-tax-free benefits for the executive.

Split-dollar loan uses a life insurance policy owned by the executive and paid for by the CU. The CU’s payments are treated as a loan under IRS regulations (hence the name), and if the CU is to be repaid premiums plus interest at the IRS-determined Applicable Federal Rate (AFR), there is favorable tax treatment.

Simply put, SDL captures the spread between policy performance (which varies) and the AFR (which is fixed for each CU advance). While actual spread matters the projected spread has far more influence on expected benefits. Therefore, the projection rate you use is crucial to designing and monitoring SDL. Insurance illustration rules limit the maximum projection rate, however, prudent design demands a planning rate below that maximum.

One of the key decisions in designing SDL is what type of policy to use – whole life (WL) or indexed universal life (IUL). We use both types, helping clients match the executive’s profile to the appropriate product.

Whole Life is the oldest form of life insurance. It has strong guarantees with an annual dividend rate set by the carrier that doesn’t change much from year to year. With a 25+ year general decline in fixed income rates, it’s no surprise that dividend rates have changed. The table below shows the number of decreases from 2002-2021. The maximum projection rate in WL is the current dividend rate. We recommend a WL planning rate 0.5%-0.75% below the carrier’s 2021 dividend scale.

Indexed Universal Life has a crediting rate based on the change in an external index, most commonly the 1-year change in the S&P500™. An author of a recent article wrote that IULs are “expected to lose money about half the time.” This is a stunning lack of understanding of how IUL works since cash values are never exposed to the index and there is a guaranteed minimum or “floor” rate. The table below is based on 25 years of 1-year measuring periods

The maximum projection rate in IUL is a function of the IUL cap rate, and like WL dividend rates IUL cap rates have declined. While you can still actually get a 9% crediting rate for any measuring period, the projection rate is lower. We recommend an IUL planning rate that is 0.5%-0.75% below the maximum, and are currently using 5%-5.25%.

So which is the “right” product? While neither WL nor IUL is inherently better the key for us is the first distribution date. If you have less than 10 years before the first scheduled distribution, we generally favor WL as it provides greater confidence in meeting the projection. Beyond that, the upside of IUL may be more desirable. Whichever you choose, stress the initial planning rate by running two lower alternatives to see the impact on the targeted distribution.

There are other features of WL and IUL that are key to a sound SDL plan. Call IZALE Financial Group for a free consultation.

John is “retired” now, forced into by the age of 50 due to Multiple Sclerosis or MS. His disability progressed quickly before stabilizing, but it took away his ability to operate DaVinci. His gait changed and he became less stable. Not only could he not work, his fishing is far less frequent than it used to be.

As tragic as John’s situation is, it could have been far worse. John worked for an employer who valued its people enough to offer a strong group long-term disability or LTD plan. Since John met the requirements for benefits (and there’s no current cure for MS to allow him to recover), 60% of his salary is replaced until he’s eligible for full Social Security benefits.

Like all group LTD, however, there’s a maximum benefit that is far below John’s pre-disability earnings. John had a good neighbor and friend, however, who showed him the value of insuring the risk that his employer didn’t. The individual policy that John bought “covers the gap” and nearly 70% of all of John’s pre-disability earnings have been replaced.

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

In December of 2016 while preparing for an upcoming CBAI, Community Banker's Association of Illinois, annual Director's Conference in Springfield, IL, Phil Aderton, VP of Sales, interviewed one of IZALE's clients. The best marketing is Peer-to-Peer. Phil wanted to know why a member community bank became an IZALE client. He wanted to be able to share this with other Bank Directors, CEO and influencers who would be at the conference. Here is what Phil discovered from Steve Wallace, the President of The Community Bank of Trenton:

“During our Strategic Planning session several years ago, our trusted CPA advisor posed the question as to how we planned to retain and reward the CEO and, perhaps more importantly, his young upcoming leadership. Our Chairman was planning to step away from the bank board and is our largest shareholder. He was concerned that his investment would be Navigating the Future with IZALE at risk, if the board didn’t look into an executive benefit plan. At the urging of our CPA Advisor we engaged three vendors to present their products and services. It was only IZALE that provided a way to meet our short term goals, but also gave us a strategic plan to meet the long term goals through their design of an executive benefit plan.

It was IZALE’s service of clear direction that helped us decide they were the firm to do business with. IZALE was interested in where we wanted to go, & showed us how to get there. If any bank is strategies I tell them:  Talk to IZALE! I invite anyone who wants to talk about how to keep our Community Banks thriving as we move forward, here is my number 618-224-9258. Call, let’s talk!”

Steve Wallace President
Community Bank of Trenton, Trenton, IL