Nonprofit Organizations | Executive Compensation Program Considerations

Nonprofit organizations continue to face unique challenges when designing competitive and compliant executive compensation programs. One increasingly common strategy—loan-regime split-dollar—helps nonprofits avoid the 21% excise tax imposed under IRC Section 4960 on the top five executives earning $1 million or more. However, these rules can affect far more than just the highest-paid leaders.

Under IRC 4960, a “covered employee” includes any current or former employee who was among the five highest-paid in any tax year beginning after December 31, 2016. Once designated, they remain a covered employee for life, meaning more than five individuals may eventually fall under the excise tax rules.

To meet compensation, retention, and recruitment needs while navigating these regulations, nonprofits are increasingly using a variety of life-insurance–based executive benefit solutions, including:

• SERPs (Supplemental Executive Retirement Plans)

• Section 162 Executive Bonus Plans

• Endorsement Split-Dollar Arrangements

• Salary Renegotiation & Reduction Loan-Based Split-Dollar

Below is an overview of each key strategy.

Supplemental Executive Retirement Plans (SERPs)

SERPs remain a core element of nonprofit executive compensation. Under IRC Section 457(f), nonprofits provide a written promise to pay future compensation, either as:

• Defined Benefit SERPs: The benefit amount is determined in the future.

• Defined Contribution SERPs: A fixed contribution is made annually and grows based on a set metric.

Because the present value of a 457(f) plan becomes taxable to the executive once they have a legally binding right to the benefit—and, critically, when that benefit is no longer subject to a substantial risk of forfeiture—defined benefit SERPs are seeing increased usage due to greater planning flexibility.

Nonprofits often purchase life insurance as the informal funding vehicle. Cash value can be withdrawn to meet promised benefits (including disability benefits), and death benefit proceeds can cover survivor payments and reimburse the organization for costs and time value of money.

SERPs must also comply with Section 409A to avoid immediate taxation, a 20% penalty, and retroactive interest. These plans require careful design and ongoing administration.

A core challenge with SERPs:

Lump-sum taxation of the present value may trigger the excise tax for the organization.

Executive Bonus Plans (Section 162)

One of the simplest strategies, an IRC Section 162 Executive Bonus Plan works much like an enhanced 403(b)/401(k) alternative.

Under this structure:

• The executive purchases a cash value life insurance policy.

• The nonprofit provides bonus payments to fund the premiums.

• The policy is “maximum funded” while maintaining non-MEC status so cash values can later be accessed tax-freethrough withdrawals and loans.

Employers may choose to “double bonus” the arrangement to cover the executive’s income taxes on the bonus—keeping the executive cash-flow neutral.

To support retention, the employer may add a restrictive endorsement limiting access to cash value until certain conditions or vesting schedules are met.

Bonus plans can increase executive taxable income, potentially bringing an individual closer to the IRC 4960 excise tax threshold.

Loan-Regime Split-Dollar

Nonprofits can structure loan-regime split-dollar arrangements in two primary ways:

1. Traditional Loan-Based Split-Dollar

The nonprofit loans funds to the executive to purchase a life insurance policy.

• The executive is taxed only on imputed loan interest.

• After repaying the loan (from policy cash value or other sources), the executive can take tax-free withdrawals and loans during retirement.

• Remaining death benefit goes to their beneficiaries income tax-free.

For reporting:

• Large benefit accruals under 457(f) must be disclosed in Section J of Form 990.

• Split-dollar loans are generally reported more subtly on Schedule L, with only imputed interest showing in Section J.

This approach works well when structured at the outset of an executive agreement and can help keep total compensation under the excise tax limit.

2. Salary Renegotiation & Reduction Split-Dollar

Here, the nonprofit lowers future executive salary to remain below the excise tax threshold, redirecting the reduction toward a split-dollar policy.

Key requirement:

Salary renegotiation must reflect future compensation, not deferred existing compensation, to avoid triggering 457(f) rules.

Endorsement Split-Dollar Arrangements

In an endorsement split-dollar plan:

• The nonprofit owns and controls the policy, including cash value.

• The executive receives a portion of the death benefit via endorsement.

• The executive pays taxes annually on the reportable economic benefit (value of insurance coverage).

• The cash value appears as an asset on the nonprofit’s balance sheet and can be borrowed against.

If the nonprofit transfers policy ownership to the executive in the future, the transfer may be deductible, but is treated as compensation—potentially triggering the IRC 4960 excise tax.

Final Thoughts

Is your nonprofit financially positioned to implement an executive compensation program of this scale—usually designed for CEOs or top executives? Do you have board or executive committee support to explore these strategies? And will implementing one of these plans help you retain the leadership talent needed for long-term mission success?

If you’re considering any of these solutions or want guidance evaluating what’s appropriate for your organization:

📩 Contact: js@joesimon.solutions