Stearns Financial Principal Eric Stearns and Senior Executive Consultant and Director of Business Development Jay Rogers are back on “C.U. on the Show,” sharing real-life use cases of their groundbreaking, proprietary method, the LifeNotes Strategy.
In previous episodes, Jay and Eric introduced the strategy and how it has helped credit unions fix or enhance their credit union-owned life insurance (CUOLI) plans. You can get up to date on all three episodes with Stearns here. To summarize, LifeNotes involves credit unions and executives selling their life insurance-based plans, such as collateral assignment split-dollar (CASD) or credit union-owned life insurance (CUOLI), which no longer produce intended outcomes. The strategy helps credit unions develop adaptive programs that reduce duration risk and increase value to them and plan participants. In exchange, the plans are modified, for example, to provide a guaranteed annuity tied to a fixed maturity date rather than floating while maintaining the tax-free nature of the plan’s payments.
In this episode, Jay and Eric share how the LifeNotes Strategy can be particularly valuable for collateral assignment split-dollar and 457(f) plans. Eric explains that CASD and 457(f) plans are highly popular as part of a credit union’s retention strategy because of the life insurance benefits and tax-free retirement payments to executives. However, he notes they’re dependent on illustrated income projections to work, which could be affected by a shifting interest rate environment and insurance carriers producing lower-than-average dividends. The result is that credit unions are investing more than ever to meet future projections while waiting until maturity or the passing of the executive for repayment of the plan’s loan. Eric shares two examples of how the LifeNotes Strategy can help rescue underperforming life insurance-based compensation programs.
Use Cases of the LifeNotes Strategy
#1 A CASD Is Not Expected to Perform for the Duration of the Policy
In this example, Eric shares how a retiree stood to receive approximately 20 years of withdrawals from their CASD. However, because of lower interest rates and the insurance company’s ability to produce projected dividends, illustrations showed the executive would likely not receive up to four of their last withdrawals from the plan. As a result, the credit union considered overfunding the asset to meet the projected benefit, essentially taking the asset underwater from an auditor’s perspective. Instead, using the LifeNotes Strategy, the credit union could redesign the plan to a fixed duration of 10 years and a guaranteed annuity for the executive. While the modification reduced the amount of pure life insurance the executive would earn, the guaranteed annuity actually provided up to 10% more income over time. Stream the episode to hear the full details, including:
- How the credit union added diversification on the underlying asset and removed duration risk to get repaid sooner
- How the executive was less dependent on the credit union board’s annual approval with the redesign of the guaranteed annuity
#2 Augmenting a CASD In a Rising Interest Rate Environment
Due to rising interest rates, a credit union would have to invest more into its 20-year CASD plan to maintain the dollar-for-dollar value for its CEO, who would be retiring at 65. In this case, the LifeNotes Strategy enabled the credit union to separate its investment from the executive’s benefit. Because the credit union wanted to retain the tax-free nature of the withdrawal payments to the executive, it instead opted to take a lower return for a shorter amount of time. For example, instead of earning 3 to 4% over 40 years, the credit union chose to make 1 to 2% over 15 years. The tradeoff of time versus money gave the credit union flexibility and reduced its opportunity cost to optimize every dollar it invested into the plan.
Stream the episode to hear the full details, including:
- How the LifeNotes Strategy makes it easier for a credit union to unwind or separate from a CASD based on its relationship with the executive
- How a credit union can sell its portion of the policy to earn necessary liquidity without impacting its retention efforts or the executive’s benefit
Hear the full conversation to learn more, including:
- How converting a 457(f) plan into a CASD using the LifeNotes Strategy could potentially provide a windfall for a credit union and a series of tax-free payments for an executive
- Other anticipated scenarios in which LifeNotes could be valuable, including when long-term care or spousal insurance benefit needs change
- How the LifeNotes Strategy embodies the “people helping people” credit union philosophy, helping advance the credit union movement
Jay Rogers, Eric Stearns, and Stearns Financial are not affiliated with or endorsed by ACT Advisors, LLC.
Audio Transcription (pulled from the podcast)
Doug English 0:00
In this episode, we’re continuing our conversation with Eric Stearns and Jay Rogers from Stearns Financial. We’re going to dig into the use of the LifeNotes strategy for common credit union deferred comp plans like 457F and collateral assignment split dollar plans. In my case, when I see a credit union executives financial plan, and most of the collateral assignment policies I’m used to seeing tend to target that 50 to 60% replacement ratio at retirement. And when we put that into somebody’s plan and analyze it out, it is absolutely mission critical that that happen, if that was to go away or be materially less in value most executives financial projections are going to fail or be dramatically affected. So, I think that this is a critical point with what’s happened in the equity markets, obviously, have reduced a lot of return expectations that may have been indexed a policies. And then the, the low interest rates that we had the last several years may have caused some underperformance of traditional interest rate bearing policies. So, Eric and Jay, let’s talk about some uses of the LifeNotes strategy for collateral assignment and 457F. So, which one should we start with?
Eric Stearns (01:32)
Why don’t we go ahead and start with some of the collateral assignment pieces? And I want to set the stage and build on what you said a little bit in that, when we approach collateral split-dollar plan, a 457(f) plan, whatever portion of deferred comp we’re looking at—there are really a couple of things. And I think you made a very good point in that it really has to perform. In other words, as a CEO, to those CEOs who might be listening, you’ve made a life choice to work at a credit union and not a bank, and not somewhere else, where it could have been more lucrative, where there could have been equity, there could have been a lot of other things that are involved. And that means your compensation package was a little different. And it also means that many of our clients have the biggest asset they own from a retirement standpoint as their split-dollar plan. And it needs to be the most secure portion of that program. Now the advantage of that is it allows you to take different risks that allows you to do different things with your 401(k); it allows you to change the metric of when you take Social Security and it gives you a lot of flexibility. But for those things to happen, it has to perform. And the way in which it performs is dependent often on the underlying life insurance. If the original program is funded so it minimizes the investment and maximizes your return, given the current set of assumptions, it’s all down to those assumptions. And what we have seen and kind of to the prior podcasts, the reason that we came up with this strategy is that those assumptions might have been reasonable assumptions 10 years ago, or five years ago, or even the beginning of this year. But those aren’t realistic assumptions. And the problem with that is the credit union then puts all of this time and effort and investment into crafting a retention strategy that’s based on certain payouts and certain objectives, and then essentially cedes the control of that, the success of that program, to an insurance company’s product. And I would say that tradeoff is a reasonable tradeoff, because it could be worse; you could be trading it off to market returns, you could be trading it off to a mutual fund. Here, we’re turning it over to an insurance company, which is generally going to be whole life or some combination of whole life and/or indexed universal life that is going to have a very stable return over time. So it’s minimizing that, but there’s still some aspect to that, especially if it’s funded at a level where interest rates change, as we say, assumptions change inside the life insurance, it starts to have an impact on the projected benefit. And I’m going to give you a case study. Actually, I’ve got a couple of case studies on this. But one is a retired executive of a plan that was inherited by a client of ours that came in as part of a merger. And this retired executive was 10 years into their program, this being the 10th year, and they had 20 years of total planned withdrawals. And looking at the decrease in dividend rates, at the insurance, the whole life insurance carriers, and the decrease in the cap rates, leading to a lower availability of projecting future results on the IUL programs, we determined it was very unlikely they were going to have those last three withdrawals, maybe even last four withdrawals, and still be able to repay the credit union in full and do everything that needed to happen from a plan execution standpoint. As mentioned, this whole LifeNotes Strategy was born out of this concern, born out of this scenario. So this is exactly what it’s supposed to do. We put this program and utilized the LifeNotes Strategy. And we were able to have the credit union be repaid in full in 10 years instead of waiting until life expectancy or the full lifetime until death, until there was a mortality event. And this particular executive retired at age 60, their withdrawals were at age 80, and they were very likely to have a life expectancy close to 90. So we were looking at 20 years, even 10 years into the withdrawals, we’re looking at 20 more years until the credit union is going to have that return of cash. So we were able to essentially cut that in half; their duration became a fixed 10-year number at the same interest rate. And they were obviously much happier about that, especially with a plan that came in as part of our merger. From the executive standpoint, we were able to have a 10-year guarantee on that payout. In other words, we were able to exchange or to use the strategy to redesign part of the program to allow for an annuitization. Meaning there was a life insurance company guarantee; I like to caveat the word guarantee because there are lots of guarantees in the world, you can create a guarantee by overfunding it to a point where it should never fail, which is pretty common. You know, that’s essentially what you’re looking at it most split-dollar plans as they’re funded to a point where they have a 99 or 95% probability of success, which, you know, that’s one form of a guarantee; another form of a guarantee as an insurance company saying this is our contractual obligation to policy owners or annuitants. And then, of course, there’s government guarantees, which everyone can say that it’s a risk-free rate until you’re holding a bunch of Treasury bonds when things start going crazy. And now you’ve taken losses, and you’re like, wait, I thought there was a guarantee. Well, it’s still, yeah, it’s a guarantee until they print all the money and devalue the currency. So everything has some amount of risk to it; it’s just a matter of what you’re being compensated for. And here, the executive was able to essentially give up a portion of the life insurance in exchange for a guarantee. And as I said, there’s no such thing as a free lunch; what are you giving up, what’s the tradeoff is that there will be less pure life insurance to the executive. But it also means the executive is still going to receive a guaranteed amount of life insurance and the guarantee of the future payout to a beneficiary. So it was a very worthwhile trade in this instance. Now, that doesn’t mean they have to do that. We can actually use this LifeNotes Strategy in a couple of ways to fix or to rescue a split-dollar plan. And one of those ways is to look only at the credit union side of the transaction, looking at the promissory note, or the promise of the repayment as a receivable asset, and analyzing that and bringing that into the LifeNotes Strategy to have an earlier repayment. And then separately from that is the actual calculation of the benefit and how the manifestation or the payment of that benefit and maintaining it in a way that allows us to or create it in a way that allows us to preserve the favorable taxation. So at the end of the day, the nice benefit about a split-dollar plan is that it is a non-taxed withdrawal that comes out of the life insurance from the tax basis and cash values of the life insurance. So we want to maintain that but also maximize how much they’re going to get. So in this particular instance, the executive getting a 10-year guaranteed payout, we actually increased their benefit by about 10% actual dollars in your pocket at time of payout. So there was a nice win-win for both parties and it shortened the duration. It increased the credit union’s diversification on the underlying collateral and allowed for this income and recovery. The other side benefit to this for the credit union was that this particular plan had less cash in it than was being booked as a total receivable, total asset at the credit union. In other words, for lack of a better term, underwater, it had a personal guarantee involved. So the executive had to show substantial assets in order to have the credit union recognize the full face value of this loan. And their accountants get a little, the CPAs look at it, the auditors look at it and say, well, you know we’re going to footnote this in a particular way. And we’re going to make sure you’re checking this person’s personal assets. The side benefit to this program is that it’s fully collateralized once we do this. It’s fully collateralized by cash and/or cash value. And what that means is the credit union no longer has to collect personal financials from the executive; it creates a better or a cleaner separation between a retiree and the board that may or may not know them 10 or 20 years down the road.
Doug English (11:11)
Yeah, well, I want to circle back on several points you just made. So I’m used to that occurring, right for us, for the folks that we have ongoing relationships with each year, we’ve got the split-dollar illustrated as a fixed income in our system, and look at how we’re looking at how a person is living, because that’s what the vast majority of folks do. Right? Very few executives actually accelerate their withdrawals, even though that’s an interesting strategy sometimes. But so, it’s a fixed income in their life. But every year, there’s the process, and the process is getting that withdrawal approved, through the board process and validating that the policy is still in line with what was illustrated. So if you use the strategy, the LifeNotes Strategy, to make some changes, you can potentially eliminate the need to go through that annual process. Is that what you’re saying?
Eric Stearns (12:14)
To some degree. I mean, there is always going to be some due diligence the board and the credit union needs to accomplish because they still own a receivable asset that is a financial vehicle for the financial investment of the credit union. So they still need to do that annually. However, it does eliminate the fiduciary responsibility of the board with respect to execution of the withdrawals. And the benefit itself. And as mentioned, we used a guaranteed annuity on this, which means it’s going to pay out automatically every year or every month, every quarter, or whatever the executive chooses, without having to go through an approval process, without having to go through any kind of back and forth, it’s basically one approval, sign off to make that happen. And the reason you can do that is because of that full collateralization aspect to it. Now the credit is completely secured, they’re secured, secured in a way that abstracts it from the executive’s personal guarantee that’s involved. So we can eliminate a personal guarantee or at least make it so the credit union is no longer in that position.
Doug English (13:32)
Thinking about it from the executive’s personal standpoint. So critically, the split-dollar is a series of tax-free payments and that allows us to do all kinds of shuffling of shells, and in trying to achieve some tax arbitrage in a variety of ways. If you switch, and it is now an annuity payment being received over the same period of time, hopefully the same dollar value, you continue to retain the tax-free nature. Is that what you’re saying?
Eric Stearns (14:05)
Yeah. So there are a couple of ways we can approach that. The first is, we can keep it, we don’t have to use an annuity, we can continue to use the life insurance and kind of keep it as is. It depends on the executive’s particular tolerance for risk-reward tradeoff. There’s some amount of upside they can give up to have the absolute guarantee of an insurance company versus a programmed withdrawal from the life insurance. Now that said, the tax basis is the tax basis. So you’ve taken out a loan, that’s your tax basis, and to the extent we’re returning that tax basis there’s no taxation on that money. It’s going to be repaid and it’s all compliant with how the IRS regulations look at split-dollar plans. Now that said, inside an annuity in and of itself the annuity will earn a rate of return. What that means is, if we use an annuity, there’s probably a little bit of taxation that will occur. But that also means you’ll have a higher benefit. So for example, if I’ll just make up some numbers here so it’s not traceable back to my example, but I’m going to say a $50,000 annual payout from a split-dollar plan, that would be a non-tax withdrawal of $50,000 per year because it’s a return on the cash basis, and then a policy loan. We can keep that same strategy, 20 years of $50,000 per year. If we put it in an annuity, your net benefit might end up being 55,000 or 60,000 per year. But of that, 40,000 or some amount of that would be tax return of basis, non-taxed, but then the interest earned would generate some taxable income. And that taxable income is what the increase of the net is after you’ve paid the taxes, an amount over 50,000, up to 55 60,000, somewhere in there. So you end up with a bit more, but you introduce some taxation. Now, the tradeoff is that instead of right now, when you take a policy withdrawal, there’s really no reporting. It’s a return of tax basis. You don’t get a 1099; it’s just a transaction of personal money from your left pocket to your right pocket. Under this scenario, where we have the annuity, there is a 1099 R that’s issued that discloses the non-taxed amount and the taxable amount. So it’s a little bit different from a reporting standpoint. But at the end of the day, you still do achieve the goal of having a large chunk of it being the non-taxed, the non-taxed portion. Those are all considerations we work with in making the decision of what the executive wants.
Doug English (17:15)
All right. So Eric, I want to ask another question about this first example for the collateral assignment, because what I’m hearing you say is that, what enables the ability for the credit union to shorten its duration, and the executive to potentially retain their same payment stream, is giving up the large bump that happens when the person passes away? When we build the financial plan we put that way out there, right? So we’re testing would that person’s spouse be secure if that occurs? But if something happened to them earlier, that could be a big deal. So am I correct to assume that in the design, it would be possible to kind of balance those things out of like, we sort of made sure there was a couple million dollar benefit for the spouse if the executive dies at an early age but maybe that disappears over time. Is that part of the options using the strategy?
Eric Stearns (18:33)
Absolutely, yes. So we really look at it from a life insurance needs standpoint. Specifically, if somebody’s still working, there is a loss of income that would occur to that executive’s family, and those are the kinds of things you want to make sure you’re insuring against from a risk standpoint. And we want to make sure those things stay in force. That view of the world changes a bit once you retire; you’ve got your kind of your known assets and things hopefully are working according to plan. And that’s when we see this strategy coming into play. It’s closer to retirement. I would say we start from the beginning or build it in from the beginning but where it really becomes valuable is in the post-retirement period. Because that allows an executive to choose to have less life insurance that’s applicable to their beneficiary. And to make that tradeoff and use the trade to guarantee the living benefit of the withdrawal. And you can still, like we have examples of executives who aren’t choosing 100%. In other words, they’re not saying, well, I’m going to take as little life insurance as possible, they’re saying I want to make sure I have, call it $100,000 no matter what, even if I take all my withdrawals. I still want to have $100,000 because there’s going to be some final expenses. And then other executives are in a different family situation and might need a bit more of that. And we want to keep that in force as well. So that really comes down to the personal planning scenario we’re looking at. At the end of the day, if they want to guarantee that something has to be traded. There’s no such thing as a free lunch; there’s got to be some tradeoff to make that happen. But they can choose what that tradeoff is. And that’s the flexibility of the program; it gives us the option instead of only locking us into one potential outcome.
Doug English (20:39)
Well, so that’s going to be our example A and in example A we got an underperforming policy, the credit union couldn’t get repaid and have the illustrated income occur to the executive so you use the LifeNotes Strategy to kind of break those things apart. And then give the credit union, the executive, flexibility in that situation. Let’s go to example two.
Eric Stearns (21:05)
So as I mentioned, the whole strategy was born out of that idea of example A, an underperforming plan. What we realized, especially over the last six, eight months now, is that this program, this strategy we have developed fits extremely well in a high interest rate environment, a rising interest rate environment. And the reason is because we’re achieving an abstraction or a separation of the executive’s loan and the credit union’s investment, we can still go into a new split-dollar scenario, which, if we imagine a new split-dollar plan—this is one, a recent one we’ve done, $600 million credit union CEO, there’s going to be a 20-year benefit with three in-service retention withdrawals, and it’s 15 years until retirement; this executive’s 50-years-old, retiring at 65. And under this scenario, right now, the applicable federal rate is much higher, which means the credit union would be in a position where they’d have to put in significantly more cash into the program as an investment to produce the same dollar per dollar of benefit that just two years ago would have been far less investment, because now the credit union is essentially being forced or pushed to create to keep the loan itself tax-free. We can either introduce taxation to the executive from an imputed interest income standpoint or the credit union can increase the interest rate to the current AFR, and the applicable federal rate is hovering around 3% or so. Which means the credit union has to put in more money. What the strategy allows us to do is to separate those two things and still provide for a market rate loan to provide the benefit to the executive and keep that tax-free to them, no taxation in that because it’s a market rate loan. But then have the credit union or allow the credit union to only take a 1% return or a 2% return. And for some amount of time, and you might ask, well, why would a credit union want to take 1% instead of 3%? Well, that doesn’t make sense. Well, actually, what it does, it allows for flexibility. So you can choose the duration. Because you know, as I started the conversation off with on the last podcast, it’s on the last episode, it’s a tradeoff of time versus money. And if the credit unions are looking at this tradeoff, now you can make a conscious choice to say, well, do we really want 3% in this case, the 50-year-old executive’s life expectancy means this is going to be out on the books for 40 years. Does the credit union really want—this one was about $3 million—did they really want $3 million hanging out for 40 years at 3%? Or would they rather take a 15-year 1% note and get repaid at retirement? And that’s exactly what the credit union chose in this instance, by taking that 15 million at 1%. It allowed them to put $3 million into the plan instead of $6 million into the plan, which would be the equivalent, we’d have to put in 6 million to get repaid at year 15 at 3%. So there’s a very clear tradeoff of how much money needs to go into the program at one interest rate to produce every dollar of benefit. And if we can optimize this so we can have the least amount of investment, the least amount of opportunity cost for every dollar of benefit that’s coming out of the plan, that is how we achieve an optimized net economic value of the program. It’s essentially taking all things considered, how do we optimize that? And this strategy allows us to have that abstraction so in a high interest rate environment and a low interest rate environment in a middle interest rate environment we can have the choice to optimize it for the credit union rather than kind of take whatever’s being given to us at the time it goes in.
Doug English (25:42)
So example B is the ability to choose your duration and to fix that duration as is appropriate for what’s going on in the relationship with the executive with the credit union, and then to change it as things change. Because I’ve certainly seen several executives I can think of who job changed. And the credit union still has the policy for an executive who didn’t stay there all the way until retirement and is kind of stuck in that arrangement. What I think I understand is they aren’t necessarily stuck in that arrangement with the LifeNotes Strategy; they could consider other choices.
Eric Stearns (26:30)
Absolutely. And again, so some of the things that kind of came along for the ride, once we figured out how to fix in-force plans, was this idea that now that these things are abstracted a bit, it allows us to unwind a split-dollar plan very easily. So now we can create a strategy, a better strategic outcome for the credit union, because they can design their executive benefit strategy knowing if it doesn’t work out, it’s very easy to unwind. We’ve increased liquidity diversification, we’ve abstracted or separated some of the cash values from the death benefit and the benefit from the taxation so you allow an organization to step away from the plan, if they need to sell it without impacting the benefit. We could even imagine a scenario where the credit union needs liquidity and decides to sell their portion of the plan and the executive is still there. There are a lot of possibilities we open up by using the strategy. And you’re certainly unwinding with our very deep knowledge that in this one of the things we have done a lot of is to take plans that are in-force set up, what I would say, plans we either we set up or plans other producers set up, and then we unwind them or show credit unions how to unwind them in a financially constructive way, instead of, as they say, throwing the baby out with the bathwater and taking a loss. You don’t have to do that in a plan. And now with the LifeNotes Strategy that’s built in from the beginning and the way we unwind, this becomes a very clean process.
Jay Rogers (28:26)
Yeah, and I think this is a good time to touch on one of the components here; we talked about different plans that were either changing, or were augmenting and getting back on track. You know, as we’ve touched on in each of the episodes we’ve done with you, we’re really excited about how this will lead to other firms using this product. It’s not just your local insurance rep who will sell a split-dollar plan that could end up needing augmentation down the road and realignment, and from our firm to our competing firms, we have all through a whipsawing interest rate environment and decreasing dividends over the last several years had to make adjustments. And so what we believe is that the LifeNotes Strategy has created a new and in our opinion, a best solution for fixing a lot of these plans. And we want the groups we have historically competed with, we want to work with them and the strategy to implement and fix those plans. And we’re happy to enter into arrangements where they’re using our strategy to fix plans, and we’re not going to go in there and take their client from them. It’s something that can be used for the betterment of the credit union community. And if we can work with them, I think that’s the best play.
Eric Stearns (30:02)
Yeah, I get all nostalgic about what it is doing like the way the credit union movement really helps the world in creating financial solutions that may not otherwise be able to be utilized by people. And part of that is the commitment we as an organization make to our clients in having these programs work. And whether it’s the plans that went in place in the early ‘90s, when my father and his colleagues were first kind of coming up with these things, all the way to plans we put in today, we want to look back 30 and 40 years from now and that’s how we measure success is on a 30- and 40-year timescale. Probably not me because by then I’ll be retired. No, I don’t think so. But a 30- and 40-year timescale so when a board of directors we’ve never met looks back on this and says they did the right things to make the credit union succeed, we’ve retained talent, we’ve created incentives, we’ve had people retire successfully. And these have been good plans. And that commitment is broader than just the plans we happen to put in place. It’s the plans we pick up too. I never want to hear the horror story of the credit union down the street that had a plan fail because they didn’t have the toolset, they didn’t have the expertise or they weren’t relying on the experts they needed to rely on to create a plan or fix a plan or adjust the plan as the world changed.
Doug English (31:55)
I can imagine so many situations where the flexibility would be a value, and I just want to have you guys make comments around any of these that just immediately come to mind. I can imagine a situation where it’s a couple when the plan is built and when the retirement initially begins. But then one of the people passes away, let’s say it’s the spouse, not the retired executive, and perhaps the insurance need is no longer there or is dramatically reduced. So what I think I’m hearing you say is it’s conceivable that when any executive benefit specialist is doing their annual review with the policy, they need to be aware of life changes that might have occurred that would cause the overall structure of life insurance with this big amount that comes when you pass away. Is that still a valid design? Or is it no longer needed or less needed? So therefore, is it correct to assume that if that event occurred, the spouse passed away, the insurance need is dramatically less? Would it be likely that the executive could come into the pool and potentially get an increase in net revenue as a result of removing that need for life insurance?
Eric Stearns (33:34)
So, I would say that on a case-by-case basis, that would be a consideration we would take into account. I don’t have a direct example of that one today. But as I said, we’ve been in development on this program for a couple years but we really just have been rolling it out for a few months. And I’m sure that will come up. And I can’t see any reason why not. But that’s going to be a question for me and my analyst. And many hours on Excel.
Doug English (34:03)
Yeah, just thinking through it, I would bet the longer the time is and closer to the assumed mortality age, the greater the opportunity for that to occur because of all the insurance cost over all that time. But that’s an interesting use case. I can also imagine someone getting into a very, very expensive long-term care situation so their need for cash is very front-loaded. And their need for death benefits is secondary. And so this might allow them to get access to more funds for that long-term care situation potentially.
Eric Stearns (34:40)
Absolutely. That is certainly a use case for the LifeNotes Strategy. And some of the riders that are built into the life insurance policies these days—I think that’s an underrecognized or underutilized benefit to these programs—are some of the long-term care aspects of the programs themselves. So this LifeNotes Strategy, when we approach it as a toolset, also allows us to look at things that are already in force from a 457(f) standpoint. So there are a lot of programs that CEOs, executives have at credit unions that are really based on the other major bucket we have available to us from the IRS, which is 457. And an F plan in particular being kind of the unlimited plan where it’s targeted, at least nominally, at either retirement or some date in the future that has a lump sum payout. The drawbacks to that are the taxation and the fact that the credit union has to put in, if you’re going to get the same dollar for dollar in your pocket, as a benefit, that means the credit union’s putting in a lot more money, and effectively taking a lower interest rate. So there ends up being more opportunity costs in a 457(f) in most instances once you’ve taken everything into account. The flexibility that something like LifeNotes gives us is in combining these two things. So now we’ve talked, and we had our prior episode on credit union-owned life insurance. And we’ve talked a lot about split-dollar on this episode. Now if we combine those two ideas, and you have a 457(f) that’s in force, 457(f)s are often funded by credit union-owned life insurance. But they’re also often in force for the very reason that split-dollar plans have such a long duration, that they have such an extended timeframe, or they have perception of opportunity cost. And now that we have the ability to change that, we can look at that 457(f) and do a couple of things. We can first take a 457(f) and keep that in force. And the credit union can reallocate into a higher yield investment into the LifeNotes Strategy. Meaning that life insurance that might be in force to fund the program, at least in name only, might be earning 2 or 3 or 4%. And we can now show a 5 or 6% secure overnight funds rate plus 360 basis points. Or we can, inside the LifeNotes Strategy, redesign that 457(f) plan into a split-dollar design that still looks like credit union-owned life insurance to the credit union. So if the credit union just puts its blinders on and says, well, you know, I’ve got a black box in front of me that is producing some benefit, and I’ve got an investment here that’s creating that, it’s not going to change how that black box works or looks to them, it’s just going to change the rate of return on the program. And by moving that, in moving this design from a 457(f) plan to a split-dollar plan. If there’s accrued liability, if there’s some amount of accounting treatment there that would be able to be recovered, the credit union could have a windfall from this. So there might be a strong benefit from the credit union standpoint. And the executive, if they’ve got a credit union-owned life insurance, they’ve got some insurance there we can use from a insurability standpoint; we may not even need additional life insurance, we might be able to use what’s already on the table, or just augment what’s already on the table from the executive standpoint, so they can move from a 457(f) to a split-dollar plan without having to impact the credit union’s duration on the repayment or recovery of that asset. And in my mind that really overcomes one of the biggest challenges we have in looking at executive deferred compensation—it’s great to have a tax-free benefit but it also means you have to have the credit union involved for 20 years post-retirement. And now we can eliminate that very easily without having to overfund the plan. I would say the traditional way of doing a split-dollar plan that had a crawl out at retirement was just to overfunded to the extent that the earnings would be able to repay the credit union so you would put in an extra sometimes even double or triple the amount of money to make that happen but you would get repaid in 15 years. Well, now you don’t have to put in any more money to make that happen. And that’s really the flexibility of the strategy is that it allows you to get the money back earlier without having to put in maybe a little bit more but not having to put in multiples more amounts of investment to create the same dollar for dollar benefit.
Doug English (39:53)
Very interesting now from the executive’s share, and thinking about 457(f). With a 457(f), of course, this big tax event occurs and after that tax event occurs, we’ve got some ability to do things, but it’s not a series of tax-free payments. What I think I just heard you say is there is the possibility that the 457(f) could be converted into a series of tax-free payments using the LifeNotes Strategy?
Eric Stearns (40:35)
Doug English (40:38)
I would expect I could build some testing around this. But I would expect that to be very compelling from a personal planning standpoint.
Eric Stearns (40:48)
Yeah. And I think that certainly from a personal planning standpoint, it gives you a ton of flexibility from the credit union and the executive standpoint; it’s a much more attractive benefit for essentially the same investment amount. And as I say, we like to joke, nobody retires and goes out and buys a huge bed or bag of groceries with their 457(f) money; they’re going to take that and reinvest it. So really what you’re interested in, in general, is a stream of income anyway. And if we can do that, and do that on a tax-free basis, without the drawback—often the stumbling block or the thing in the way of a 457(f) conversion is the fact that it goes so much beyond retirement and we can eliminate that as a concern—then we really have created something that is going to be more advantageous for credit unions and executives to take advantage of.
Jay Rogers (41:43)
Yeah, and I’d like to add in here a couple reasons why an executive would want to participate in the strategy. Right, so one, we’ve talked about saving a plan to benefit that might be not on track, transferring risk from themselves into the strategy. And then the key here is getting more money and getting it faster. So we’ve talked about how on average, we’re going to see about 110% of their benefit. And the other cool thing we figured out is we’re able to get them that benefit over a shorter time frame, right? So typically it’s going to be we’re going to see options of 20 years and 10 years. And so it’s not going to be a massive decrease to get it over that 10 years. So if somebody has $100,000 a year in their split-dollar plan for 20 years, the strategy is going to be able to offer them, if it’s on track, it’s going to be able to offer them about $110,000 give or take a year for 20 years, and then it will likely be able to offer them about $205,000 a year for 10 years, right? So more money than they were going to get in their original split-dollar plan and they’re going to get it faster. I say this because we had a conversation with somebody who has a 457(f) and we’re discussing different options. And he said, look, I don’t need it all at once. I’m probably going to come out after taxes getting chopped in half on this thing, leaving with about half a million dollars. But if I could get $150,000 for five years, or $75,000 for 10 years instead, right? That makes it worthwhile to them. So, again, getting more money and getting it faster. And then the last piece, which we’ve touched on already, I think is a huge value add is not having to deal with a board of directors and a credit union that you have left in retirement, very often a board you don’t even know. So those pieces I feel like are big reasons why an executive would like the strategy.
Doug English (43:53)
Excellent, Jay, well, we have achieved the longest episode of “C.U. on the Show” ever, with this awesome content about the LifeNotes Strategy. So I congratulate the Stearns group on this innovation, and I truly love the idea that the other folks who get to serve the credit union industry, like other executive benefit specialists folks, and folks like me, can participate in the LifeNotes Strategy without breaking the relationship they have with their clients. And that kind of goes to the nature of the credit union movement of people helping people. So I think that’s truly a wonderful thing. So with that, I’m going to just say, Eric and Jay, any final thoughts for our listeners?
Jay Rogers (44:53)
No, not here. Look, if you’re still listening, you are a friend of ours, because we have gone very long. So we want to say thank you. And we’re excited to talk more.
Eric Stearns (45:00)
Yeah, that’s it. I can make the commitment. We won’t talk this long in a board meeting.
Jay Rogers (45:10)
Absolutely. As Eric said, reach out to any of us on LinkedIn. And we’ll be happy to get back in touch.
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