By Jay Petty, The Sheeter Group

In December 2017, President Trump signed into law the Tax Cuts and Jobs Act. As part of this tax bill, Section 4960 was added to the tax code imposing a 21% excise tax on tax-exempt organizations for paying “excess” compensation to certain employees. Basically, this means any credit union with employees earning more than $1 million in a calendar year will be subject to a credit union-paid excise tax of 21% on the amount over $1 million.

While most credit unions do not compensate their executives at this level, many credit unions do have 457f deferred compensation plans, featuring lump sum payouts that will push the CEO and other senior employees’ compensation into excise tax territory.

Excise tax territory is not a friendly place.

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457f plans have always been inefficient from an income tax perspective. This is particularly true for executives and credit unions in high income-tax states. Many board members think this income tax expense is being shouldered by the executive, but most 457f benefits are grossed up to reflect this tax.  This results in a larger financial commitment from the credit union. In addition, we now have the excise tax making an already inefficient plan even less efficient.

What can we do?

The good news is options exist for proactive credit unions and boards of directors.  Some items to consider:

1. Wait and hope there is a grandfathering provision in the technical corrections bill. This fall congress will consider a bill including technical corrections to the new tax code. Some feel the excise tax will be grandfathered as a part of this process.
2. Restructure your existing 457f plan. Some credit unions may be able to revise the vesting/payout schedule to stay below the $1 million, such as scheduling a greater number of smaller 457f payouts to stay below the threshold. If you are considering restructuring a 457f plan, it is important to obtain qualified legal advice from an attorney experienced in this area.
3. Terminate your 457f plan and use an alternative plan. Credit unions could terminate the 457f plan and use another plan to restore the benefits the executives lost because of the plan termination. Again, it is important to obtain qualified legal advice from an attorney as there may be implications as a result of terminating a 457f plan.
4. Use a Collateral Assignment Split Dollar (CASD) plan to replace some or all of the 457f benefits. CASD plans are very popular in today’s environment. These plans are no cost to the credit union – in fact the credit union even earns income on the plan. Further, when these plans are constructed correctly they offer tax-free retirement income to the executive. They also provide the executive permanent life insurance benefits and flexibility in how to use the underlying insurance policy. Sound too good to be true? There are pros and cons to all plan types, and this plan is long term in nature and could reside on the credit union’s financial statements for decades. Be sure to work with a reputable provider who will clearly outline the pros and cons when considering a CASD plan.

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5. Use a benefit expense offset program to raise money to pay the excise tax. While we have seen yields on investments rise over the last year, opportunities remain for credit unions to squeeze extra income from their investment portfolio by using alternative investments. A benefits prefunding program could help your credit union if it will have a meaningful amount of liquidity lingering in the investment portfolio.

Whether or not your credit union’s 457f compensation payout gets grandfathered in the technical corrections bill, it would behoove your board and CEO to take a close look at the credit union’s 457f plans in light of today’s environment. The constantly changing environment bares new opportunities to take advantage of new plan types, strategies and funding arrangements. Boards must develop a relationship with a reputable and trusted executive benefits provider who can help navigate the course to stay current and offer your executives the most efficient and effective plan type.