Hidden Fees Sap Exec Benefits Plan Returns

When you’re comparing proposals for executive benefit plans, do your due diligence in two key areas:

1. Investment and management fees for a plan’s underlying investments
2. Assumptions used in projecting a plan’s returns over time

These two elements can mislead you into looking at proposals for two deferred compensation plans side-by-side and believe you’re comparing apples to apples. And choosing a plan with higher internal costs or unrealistic assumptions seriously increases the risk of the plan not achieving the assumed returns over time.

Here are some common instruments that credit unions use to fund executive benefit plans (mainly 457(f) and split-dollar insurance programs) and what to look for when comparing plans:

Two Key Things to Consider About Insurance Products

1. The internal costs (commissions and administrative/management fees) are baked into the premium and/or the surrender cost. This can make it difficult to compare products from different providers. 
2. The more complex an insurance product is, the higher its expenses are likely to be.

Let’s see how these two rules of thumb work with a couple of insurance products used in executive benefit plans:

Annuities are infrequently used to fund executive deferred compensation plans, but they do offer certain advantages—for a price.

For example, variable and indexed annuities can have higher returns than fixed annuities because they’re tied to market returns. But the internal fees are probably significantly higher. Some credit unions may opt for indexed annuities with guaranteed floors and caps on returns.

Variable or indexed annuities can have long surrender periods, as long as seven to 10 years, with steep surrender charges. And remember: Credit unions must book the change in surrender value—not in the market value—for annuities and life insurance on their income statements.

Annuities come in so many varieties today that it’s possible some can be an appropriate fit for funding a deferred compensation plan. But ask questions, especially with products advertised as “no fees, no commissions.” If you think that sounds too good to be true, you’re probably right.

Indexed Universal Life Insurance. Permanent whole life insurance has been the most common product used for split-dollar life insurance plans. 

Returns for these policies typically come from the insurance carrier’s relatively low-risk investment portfolio. You should be able to compare carriers’ dividend history for these policies and also assess each company’s financial strength through its ratings history from such agencies as A.M. Best.

However, some life insurance products that offer market-based returns can also be used in split-dollar arrangements. Indexed universal life is one example. 

IUL is a permanent life insurance policy that builds cash values. 

As with any permanent life product, IUL earnings are tax-deferred, but instead of being tied to the company’s general portfolio, they’re tied to an index, such as the S&P 500. You may be able to adjust the premiums and the death benefit during the life of the policy. The returns for this type of policy can look great in illustrations, but they may be more at risk of not achieving the assumed rate of return.

These policies offer a guaranteed floor and cap for earnings. This type of complexity can increase the underlying administrative costs. Some riders may also be available that can enhance earnings, but that also may add to the policy’s intrinsic costs.

Wrap Accounts: The Fee You Don’t See

A wrap account can be used to fund a deferred compensation plan, most often a 457(f). In a wrap account, the credit union pays a fee based on an annual percentage of the assets under management within the account, rather than paying brokerage commissions on trading. 

You’ll probably see that wrap management fee on your quarterly and annual statements. What you probably won’t see, however, are the management fees charged for the investment instruments themselves.

For example, if you have a wrap account funded by exchange-traded funds, the internal cost of the ETFs is deducted from the returns. You’ll usually have to do some digging to find those internal fees.

So, you could easily compare the annual fees of an ETF wrap account with the management fee for a standard equities portfolio used to fund a 457(f), and those fees will be just about the same.  But you’re not including the ETFs’ internal fees, which could easily be another 1% or more.

Double-Check Underlying Investment Performance Assumptions

Many executive benefit plans are structured similarly from provider to provider, but often the assumptions they use when projecting earnings will vary. 

Even for credit union executives, who know all about rates of return, it can be easy to overlook a discrepancy in the assumptions within these complex arrangements. And the higher the assumed rate of return, the more at risk the plan is of not performing up to projections.

This is all basic due diligence, of course, but that doesn’t mean it’s simple. Most credit unions don’t deal with deferred compensation investments day-to-day. That’s what makes an annual review of these plans—including all of the costs of their underlying investments—a critical step.

Ramsay Ellis is an executive benefits specialist for CUESolutions Platinum provider CUNA Mutual Group, Madison, Wisconsin.