In the ever-competitive landscape of talent retention, Credit Unions are increasingly turning to Split Dollar Life Loan Arrangements as a key executive benefit. These arrangements not only play a pivotal role in retaining top executives but also support long-term succession planning—an essential component of any Credit Union’s sustainability strategy.
Originally introduced in 1955 as a tax-free benefit, Split Dollar Life Insurance faced regulatory changes in 1964, transforming it into a taxable arrangement (26 CFR § 1.61-22). Despite this shift, these plans remain highly appealing, with 56% of Credit Unions now offering them—a number that continues to grow annually.
What Is a Split Dollar Life Loan Arrangement?
At its core, a Split Dollar Life Loan Arrangement involves shared costs between the executive and the Credit Union for an executive life insurance policy. Here’s how it typically works:
- Loan Structure: The Credit Union loans funds to the executive to purchase a life insurance policy in the executive’s name. The Credit Union retains a collateral security interest in the policy.
- Funding Mechanism: In some cases, the Credit Union pays the loan funds directly to the life insurance carrier. Alternatively, these funds may be held in an annuity to fund premiums over several years, usually for a 10-year period.
- Loan Repayment: The loan, along with accrued interest, is repaid upon the executive’s death. The Credit Union, as the primary beneficiary, receives the loan balance plus accrued interest before the remaining proceeds are distributed.
Recourse vs. Non-Recourse Loans
Split Dollar Loans can be issued either with recourse or without recourse, impacting the Credit Union’s financial exposure:
- With Recourse: If the collateral (cash surrender value of the policy and any remaining annuity balance) is insufficient, the Credit Union has the right to recover the shortfall from the executive’s estate.
- Without Recourse: The Credit Union bears the financial risk of any collateral shortfall. For newly issued arrangements, collateral shortfalls are common but typically self-correct within a few years. Brokers can provide an estimated timeline for full collateralization.
For non-recourse loans, any material shortfall must be recorded as a liability on the Credit Union’s balance sheet as of the financial statement effective date.
Common Accounting Oversights
One frequent oversight in Split Dollar Life Loan Arrangements is the failure to account for imputed interest when the loan’s interest rate is below the Applicable Federal Rates (AFR). This difference represents taxable income for the executive.For example, if an arrangement in June 2024 includes an annual interest rate of 3.5%, but the AFR is 4.79%, the 1.29% difference must be reported as W-2 taxable wages for the executive for the year. Ensuring these calculations are accurate and reported correctly is the responsibility of the Credit Union.
Additionally:
- For lump-sum annuity payments, the AFR remains fixed unless the plan agreement changes.
- If premiums are paid annually without an annuity, the applicable AFR rate applies on the payment date.
Why It Matters
Split Dollar Life Loan Arrangements are inherently complex. Missteps in their administration or accounting can lead to regulatory non-compliance, financial inaccuracies, or even strained relationships with key executives. Regular reviews of these arrangements—both from a compliance and accounting perspective—are essential.
Need Help Navigating Your Plan?
At Opsahl Dawson, we specialize in helping Credit Unions navigate the intricacies of Split Dollar Life Loan Arrangements. Whether you need a compliance review, accounting guidance, or a deeper dive into your plan’s details, our team is here to help.Reach out today to ensure your executive benefit plans are optimized and accurately managed.
