Nine Steps to Creating a Deferred Compensation Program

It’s easy for a competitor who’s courting one of your best executives to offer a higher salary and annual bonus. If that executive has a well-designed deferred compensation program in place, however, your competitors have additional hurdles to clear, including:

• Matching or exceeding future benefits—such as lump-sum payouts and/or supplemental retirement income—that your executive would forgo by leaving your credit union
• Convincing your executive that they will reward loyalty and performance in the future the way you already have

Holding on to a valuable leader is only one objective credit unions achieve today via deferred compensation. To learn why and how to use this compensation strategy, read the 2021 edition of “Non-Qualified Executive Benefits: A Guide for Credit Union Leadership,” published by CUNA Mutual Group in collaboration with CUES.

For a sample of the guide’s content, the following is a brief summary of the nine steps to creating a deferred compensation program.

1. Answer the question: Why are we doing this?

Like any executive benefit, deferred compensation plans fit within your credit union’s overall compensation philosophy. If they do, assess each potential plan by determining the specific short-term and/or long-term outcomes you expect as a result of the benefit.

A few typical objectives for credit union deferred compensation plans are:

• Solidifying a succession plan by providing incentives for the current CEO and the chosen successor to stay in place for a set number of years.
• Long-term retention of a young executive who is a likely target of professional headhunters.
• Short-term retention of someone leading a crucial initiative, e.g. an CIO who is overseeing a major IT overhaul.

2. Confirm who’s in charge of what

Establish leadership and accountability for implementing and overseeing deferred compensation plans. This includes both board oversight and appointing an executive champion who doesn’t have conflicts of interest—as some CEOs, COOs, and other C-suite leaders inherently do—regarding executive compensation and succession.

3. Set realistic target dates for implementing a plan

These arrangements can take several months to research and set in motion. But don’t delay—the time to begin working on deferred compensation is before a competitor steals one of your best executives.

4. Choose a plan provider

Consult with several providers about the options for structuring and funding deferred compensation programs. Due diligence should include verifying a potential provider’s history of stability and knowledge of the credit union marketplace.

Providers should take the time to educate your board and executives, not only about products but about the complete process of putting plans in place. Also, if you choose product providers that don’t handle ongoing compliance support, you’ll need to have internal expertise or a consultant for that.

5. Do a thorough assessment of the executives’ needs and goals

An important goal of many deferred compensation plans is to close the gap in highly paid executives’ working income and their projected retirement income.

But plans can be designed to suit many other phases of an executive’s life and career. For example, some plans are designed to provide lump-sum payouts that coincide with key stages in an executive’s life, such as children going to college or getting married, etc.

To get the most for your credit union’s investment in executives, these plans must be tailored to be meaningful to each recipient.

6. Determine the plans and the funding mechanisms

Download the complete guide for a full overview of the strengths and weaknesses of three key supplemental executive benefits products, and how they can be used in combination. Here’s a thumbnail sketch:

• Collateral assignment split-dollar life insurance: The credit union makes an advance, usually in the form of a loan, to pay the premiums for a permanent life insurance policy the executive owns. The executive, in turn, assigns the policy back to the credit union as collateral for the loan.
• Typically, the goal is to size these policies so executives will be able to tap the cash value to supplement retirement income for many years, while leaving the policies able to repay the credit union's loan when the executive dies.
• 457(f): A 457(f) plan can be designed as a defined contribution or a defined benefit plan. The 457(f) plan has no inherent contribution limits, so it offers the most flexibility to design a program tailored to the needs of an individual executive.
• Another advantage of 457(f) plans is the ability to design them with multiple vesting dates. This way, the payouts can be timed to coincide with the executive’s and/or the credit union’s needs.
• 457(b): A defined contribution plan with contribution limits, a 457(b) plan basically augments a 401(k) plan to generate more retirement income for highly compensated employees. Like a 401(k) plan, contributions are made pre-income tax, and earnings grow tax deferred until they’re withdrawn. These plans are common first steps in supplementing an executive benefits package.

7. Address the “what-ifs”

Deferred compensation agreements should spell out what happens under a variety of potential scenarios. For example:

• What if the executive leaves voluntarily or involuntarily before the end of the arrangement’s term?
• What if the executive becomes disabled and can’t continue to work?
• What if the credit union merges with a larger credit union and the executive’s job is eliminated or significantly reduced?

There are many more of these scenarios, so it’s critical to create these agreements with legal counsel who has experience in this specific area.

8. Prepare to defend the plan with examiners

Deferred compensation plans must comply with IRS, National Credit Union Administration and state regulations. Examiners require evidence that deferred compensation programs don’t pose a threat to a credit union’s safety and soundness.

Keep compliance in mind as you set up plans; coordinate with plan providers how the plans will be documented and how the providers will support you during examinations or audits.

9. Establish policies and procedures for ongoing oversight

A board committee assigned to oversee deferred compensation plans should review all plans at least annually with providers so any necessary updates, modifications and/or additions can be made.

For example, sometimes when an executive wants to take money out of a split-dollar policy, the board and executive need to assess the long-term impact of the requested distribution. To reduce the chance of competitors luring executives away, regular reviews should also ensure that deferred compensation plans remain in line with the market.

John Pesh is the director of executive benefits for CUESolutions Platinum provider, CUNA Mutual Group, Madison, Wisconsin. The 32-page “Non-Qualified Executive Benefits: A Guide for Credit Union Leadership,” fleshes out the nine steps in this article. It also covers basic terminology, industry trends, succession planning and other topics. It illustrates key concepts with common scenarios gleaned from the thousands of credit union deferred compensation plans put in place over many years by CUNA Mutual Group.