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NON-QUALIFIED DEFERRED COMPENSATION FOR CREDIT UNIONS

Shaping Success SM. NON-QUALIFIED DEFERRED COMPENSATION FOR CREDIT UNIONS. Presented by Dodd S. Griffith, Esq. Gallagher, Callahan & Gartrell, P.C. gcglaw.com To The Great New England Credit Union Show April 20, 2010. Non-Qualified Deferred Compensation (“NQDC”) is:

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NON-QUALIFIED DEFERRED COMPENSATION FOR CREDIT UNIONS

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  1. Shaping SuccessSM NON-QUALIFIED DEFERRED COMPENSATION FOR CREDIT UNIONS Presented by Dodd S. Griffith, Esq. Gallagher, Callahan & Gartrell, P.C. gcglaw.com To The Great New England Credit Union Show April 20, 2010

  2. Non-Qualified Deferred Compensation (“NQDC”) is: • Any plan or arrangement which gives an executive a legally binding right to compensation, but defers payment of that compensation to a later tax year; and • That is not an “eligible” plan such as a 457(b) plan or 403(b) plan or a “tax-qualified” plan such as a 401(k) plan or defined benefit pension plan. What is Non-Qualified Deferred Compensation? Dodd S. Griffith, Esq. ~ griffith@gcglaw.com ~ 603-545-3610

  3. Supplemental Executive Retirement Plans (“SERPs”); • Split-Dollar Life Insurance; • Change in Control Benefits (“Golden Parachutes”); and • Post-termination payments under employment agreements. Examples of Typical NQDC Arrangements Dodd S. Griffith, Esq. ~ griffith@gcglaw.com ~ 603-545-3610

  4. Section 457(f) of the Internal Revenue Code; • Section 409A of the Internal Revenue Code; • Title I of ERISA; and • Federal and state laws governing the powers of credit unions. Law Governing NQDC Plans of Credit Unions Dodd S. Griffith, Esq. ~ griffith@gcglaw.com ~ 603-545-3610

  5. The plan is not an “eligible” 457(b) plan. • This can be done by design or by accident. • Typically, it is done by design if the plan intentionally does not limit the amount that can be deferred in any specific tax year. • 457(f) plans give non-profits a means of deferring compensation for senior executives in annual amounts that exceed 403(b) and 457(b) plan limits. When is Plan Subject to Section 457(f) ? Dodd S. Griffith, Esq. ~ griffith@gcglaw.com ~ 603-545-3610

  6. Compensation deferred under a 457(f) plan is included in the gross income of an executive as soon as the right to that compensation is no longer subject to a substantial risk of forfeiture. • Thus, deferred compensation in a 457(f) plan becomes taxable as soon as it vests. The Key Feature of 457(f) Plans Dodd S. Griffith, Esq. ~ griffith@gcglaw.com ~ 603-545-3610

  7. Section 457(f) says that there is a “substantial risk of forfeiture” if the person’s right to receive deferred compensation is conditioned on: • The future performance; • of substantial services. • The IRS has historically looked to Section 83 of the Internal Revenue Code to determine this. • Now there is also Section 409A of the Code. What is a Substantial Risk of Forfeiture? Dodd S. Griffith, Esq. ~ griffith@gcglaw.com ~ 603-545-3610

  8. Section 409A of the Internal Revenue Code adds an additional, very complex, layer of regulations. • Its implementing regulations are approximately 400 pages long. • They add significant additional restrictions on how you can structure your 457(f) plans. How Does Section 409A Impact Things? Dodd S. Griffith, Esq. ~ griffith@gcglaw.com ~ 603-545-3610

  9. All 457(f) plans must also comply with Section 409A; • Some types of deferred compensation that were not subject to Section 457 are subject to Section 409A • Bona Fide Severance Plans are subject to 409A; • Split Dollar Life Insurance Plans are Subject to 409A. • Etc. (This is not a comprehensive list!) How Does Section 409A Impact Things? Dodd S. Griffith, Esq. ~ griffith@gcglaw.com ~ 603-545-3610

  10. In 2007, the IRS issued Notice 2007-62 to give interim guidance on how to treat certain issues covered by both Section 457(f) and 409A. • Bona Fide Severance Plans; and • Definition of Substantial Risk of Forfeiture. • The IRS stated its intent to issue additional regulations under Section 457, but has not done so yet. How Does Section 409A Impact Things? Dodd S. Griffith, Esq. ~ griffith@gcglaw.com ~ 603-545-3610

  11. Certain methods for trying to create a “substantial risk of forfeiture” no longer work: • Non-competes do not create a substantial risk of forfeiture under Section 409A; • Section 409A prohibits “rolling” risks of forfeiture. • Bona Fide Severance Plans are expressly subject to Section 409A. Notice 2007-62 Identified Traps for the Unwary Dodd S. Griffith, Esq. ~ griffith@gcglaw.com ~ 603-545-3610

  12. Split dollar life insurance is generally subject to Section 409A. • In addition, federal and state credit union laws and regulations place significant (but generally manageable) restrictions on the use of life insurance to satisfy a credit union’s unfunded obligation under a non-qualified deferred compensation plan. Split Dollar Life Insurance Dodd S. Griffith, Esq. ~ griffith@gcglaw.com ~ 603-545-3610

  13. Life insurance is NOT a permitted investment for federal credit unions. • Fear not – Section 701.19 of the NCUA’s regulations permits federal credit unions to purchase impermissible investments if directly related to an actual or contingent obligation under a benefit plan; and • The credit union holds the investment only so long as it has an actual or contingent obligation under that benefit plan. National Credit Union Association Rules Dodd S. Griffith, Esq. ~ griffith@gcglaw.com ~ 603-545-3610

  14. The NCUA has been pro-active in issuing legal opinions that allow for the use of life insurance to fund benefit obligations of federal CUs. • The legal opinions approve: • The use of split-dollar life insurance plans for employees of federal credit unions; • The use of a “pooled funding” approach; and • The recovery of the credit union’s “cost of funding” the benefit. National Credit Union Legal Opinions Dodd S. Griffith, Esq. ~ griffith@gcglaw.com ~ 603-545-3610

  15. The “pooled funding” approach allows a credit union to obtain a higher return on investment by holding insurance policies to maturity; • It allows the purchase of policies on individuals in amounts disproportionate to the benefits for such individuals; • Permits retention of policies on lives of retired or terminated employees to fund, in part, current employee benefit obligations; and • Permits “re-earmarking” of policies. Use of Pooled Funding Approach Dodd S. Griffith, Esq. ~ griffith@gcglaw.com ~ 603-545-3610

  16. You cannot hold policies indefinitely. • You must be able to substantiate need to retain policy to fund a current or contingent benefit obligation. • If you cannot substantiate need, then you are holding an impermissible investment. Limits of Pooled Funding Approach Dodd S. Griffith, Esq. ~ griffith@gcglaw.com ~ 603-545-3610

  17. The NCUA has issued legal opinions stating that federal credit unions may recover the costs of funding employee benefits with life insurance. • Example – a federal credit union may pay a $250,000 premium to purchase a $750,000 policy to fund a $500,000 benefit obligation. Recovery of Cost of Funding Benefits Dodd S. Griffith, Esq. ~ griffith@gcglaw.com ~ 603-545-3610

  18. The NCUA has issued legal opinions stating that federal credit unions may NOT recover the “opportunity cost” of using funds to purchase life insurance to fund a benefit obligation. • The NCUA says the “opportunity cost” amounts to a return that would have to be earned on a permitted investment – and that Section 701.19 does not go that far. No Recovery of Opportunity Cost Permitted Dodd S. Griffith, Esq. ~ griffith@gcglaw.com ~ 603-545-3610

  19. New Hampshire law includes a parity provision, NH RSA 394-B:52-a, that gives NH credit unions parity with federal credit unions pursuant to regulations adopted by the Banking Commissioner. • Ban Part 526 provides the regulatory authority, and grants NH-chartered credit unions the right to exercise federal credit union powers on thirty days’ advance written notice. State Laws Regarding Permitted Investments Dodd S. Griffith, Esq. ~ griffith@gcglaw.com ~ 603-545-3610

  20. Rhode Island Law (Section 19-5-25) permits any Rhode Island-chartered credit union to engage in any activity authorized by law or regulation for a federal credit union, which in the opinion of the director of the Department of Business Regulation, is not unsafe and unsound. State Laws Regarding Permitted Investments Dodd S. Griffith, Esq. ~ griffith@gcglaw.com ~ 603-545-3610

  21. At present, Massachusetts law appears to be more restrictive (or at least, less clear). • Section 25 of Chapter 171 of the M.G.L. permits Massachusetts-chartered credit unions to provide group life (and other similar benefits) for employees, officers and directors; and provides that ineligible directors may be reimbursed up to the net dollar amount of individual participant cost of the group benefit. State Laws Regarding Permitted Investments Dodd S. Griffith, Esq. ~ griffith@gcglaw.com ~ 603-545-3610

  22. It is our understanding that the State of Massachusetts is presently considering this issue. • There is no parity statute for Massachusetts-chartered credit unions. • Until the issue is cleared up, Massachusetts-chartered credit unions should proceed carefully (authority not clear). State Laws Regarding Permitted Investments Dodd S. Griffith, Esq. ~ griffith@gcglaw.com ~ 603-545-3610

  23. Dodd S. Griffith, Esq. Gallagher, Callahan & Gartrell, PC P. O. Box 1415 Concord, NH 03302-1415 griffith@gcglaw.com Phone: (603) 545-3610 Contact Information

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