Split Dollar Life Insurance as a Deferred Comp Tool for Not-for-Profit Organizations

72.2% of nonprofit organizations surveyed by the National Council of Nonprofits said, “Salary competition is the greatest factor affecting our ability to recruit and retain employees.”

Not-for-profit (NFP) organizations face unique challenges in developing effective incentive and retention plans for their key employees. Federal regulations restrict NFPs from using some benefit plans. Other plans available to NFPs do not provide effective long-term solutions to position organizations to compete for top talent against the public and private sectors, which have a wider selection of employee reward and retention strategies at their disposal.

Life insurance, specifically a split dollar life insurance agreement, is often an overlooked executive benefit strategy that can help level the playing field for not-for-profit organizations. A well-designed split dollar life insurance agreement can help an NFP attract and retain talented employees even in a competitive marketplace.

Examining What Works and What Falls Short: 457(b) and 457(f) Plans for Not-For-Profits

Examples of qualified deferred compensation plans available to NFPs include 401(k), 403(b) and profit-sharing plans. These plans not only limit the plan participant or sponsor’s contribution but also require that employers offer the plan to all eligible employees without discrimination.

457(b) and 457(f) are nonqualified deferred compensation plans (NQDC) available to the not-for-profit space. Exempt from most ERISA rules (Employee Retirement Income Security Act of 1974), NQDC plans provide sponsors greater flexibility than qualified plans.
457(b) plans are designed selectively for highly compensated employees (HCEs) of a not-for-profit organization. Plan participants can defer compensation on a pre-tax basis; however, the deferrals are limited to the same contribution ceilings that apply to 401(k) plans.

457(f) plans allow plan sponsors to make unlimited contributions for specified employees. The contributions accrue on a tax-deferred basis for the plan participant. A drawback to 457(f) plans is that the entire amount must be distributed as a lump sum upon vesting, subjecting participants to ordinary income tax on the distribution, which may occur during their peak earnings window.
Life Insurance: an Underutilized Option

A well-designed life insurance plan can provide a strategic reward and retention tool for not-for-profits, helping offset the limitations of qualified and nonqualified deferred compensation plans. When designed correctly, life insurance can allow:

• Unlimited after-tax contributions
• Tax-deferred growth
• Attractive investment options
• Tax-free distributions

There are no regulatory limits on how much an insured individual can contribute to a permanent life insurance policy. Once the premium is paid and mortality expenses levied, the remainder is deposited into the policy’s cash value account, which will accrue on a tax-deferred basis. The option to contribute unlimited amounts into a tax-deferred instrument while maintaining immediate liquidity does not exist in any other investment structure under the IRS tax code other than life insurance.

Split Dollar Life Insurance as a Long-Term Strategy for Reward and Retention

Split dollar life insurance is structured as a sharing arrangement between the company (in this case, the NFP) and the key employee. The cost and delivery of the life insurance policy are shared.

A typical strategy involves the company providing a loan to the plan participant as a premium payment for a life insurance policy. The policy functions as a high cash-value contract designed to deliver retirement benefits to the participant while reimbursing the company in the future.

The company will make a loan as a premium payment over time and retain an ownership interest in the amount contributed on behalf of the employee. The employee owns the policy and names the beneficiary. The policy’s cash value and death benefit are contractually assigned to the company up to the amount contributed by the company on the key employee’s behalf.

Once the key employee leaves, the company continues to have a legal right to the amount it has contributed. The company could negotiate to receive the loan repaid at departure or allow the key employee to utilize the policy until death.

The insured employee’s rights to the contract are the amount of cash value and death benefit above the amount the company has contributed or above basis. The excess cash value is liquid and can be taken by the employee as a distribution.

The report “Nonqualified 457(f) and Split Dollar Life Insurance: Which Plan is Actually a Long-Term Deferred Compensation Plan Strategy?” provides a deep-dive examination of how a split-dollar life insurance policy can be used as an effective benefits strategy by not-for-profit organizations.

Examples used in this article are hypothetical and for illustrative purposes only.

Any tax advice contained herein is of a general nature. Seek specific advice from your tax professional before pursuing any idea contemplated herein.

Want to read more about executive benefits strategies? Check out this article: Performance-Based SERPs: Adapted for a Changing Landscape.

FINRA BrokerCheck Summary: https://brokercheck.finra.org/individual/summary/1992078
Monte Harrick is affiliated with Valmark Securities, Inc. Securities offered through Valmark Securities, Inc. member FINRA, SIPC. Investment Advisory Services offered through Valmark Advisers, Inc. a SEC Registered Investment Advisor. 130 Springside Drive, Suite 300, Akron, OH 44333. 800-765-5201. OneDigital is a separate entity from Valmark Securities, Inc. and Valmark Advisers, Inc.
CA License # 0071797