While it would be easier for everyone if the employer just paid cash bonuses to key employees and left it at that, that simple solution doesn’t provide the valuable features of a well-structured executive compensation package. It is critical that you bring ideas to assist the employer–your client–with the design of any executive compensation package.
You can motivate the employer to implement a package that takes into consideration the long-term growth of the business and allows for a more efficient design. The various design features you can suggest are: 1) golden handcuffs; 2) cost recovery; 3) motivation for the long-term success of the business; 4) offset “reverse discrimination”; 5) enhancing loyalty; and, 6) leverage of the executive compensation package.
Golden handcuffs. When an employer pays a cash bonus, there is no guarantee the executive will remain with the company. You can help the employer tie the valued employee to the company by designing “golden handcuffs”–an arrangement that creates an incentive for key executives to stay with the company. Generally, golden handcuffs prevent the executive from taking plan benefits until he or she has worked for the company for a specified amount of time.
Cost recovery. More effective alternatives to the cash bonus are strategies that allow the employer to recover some or all of the costs of an executive compensation plan. By using this strategy, the employer is encouraged to think about the type of plan that best meets the needs of the business. Examples include nonqualified deferred compensation plans, employer bonuses and partial deferral of current salary.
Partial deferral of current salary allows the employer to use after-tax deferrals to help meet the eventual obligation. Most of these strategies use life insurance, with the employer paying premiums with the deferrals.
Alternatively, the employer may choose a nonqualified deferred compensation plan where only salary deferrals are allowed or a restricted executive comp package where executives also make contributions.
Motivating for long-term success. A cash bonus will only motivate key executives to a certain degree. You can suggest a design feature for an executive compensation package that will motivate the executive to strive for the ongoing and long-term success of the employer.
A bonus stock or phantom stock plan ties the executive’s benefits to the growth of the business. The latter may be measured by net income, gross revenue or other benchmarks.
Reverse discrimination. Employers often want to put away more money for key executives than they are allowed to contribute with a qualified plan. The government places substantial limitations on employer contributions to qualified plans, and IRA contributions are forbidden at higher income levels.
This is often referred to as “reverse discrimination.” Most highly compensated executives realize qualified plans will fall short of their retirement income goals.
The solution may be found in an executive compensation package that allows key employees to supplement their retirement income in accordance with their personal financial goals. The package provides a second tier of benefits to the highly compensated executives without obligating the employer to provide the benefit to the rest of the employees. In fact, the employer is prohibited from providing these plans to the rank-and-file employees.
Enhancing loyalty. An effective executive compensation package assists the employer in building a loyal executive staff. Creating valuable benefits for executives makes them feel appreciated and reduces their motivation to look for a better deal with another employer. Building loyalty helps reduce turnover and attract key executives from competitors.
Leveraging the executive compensation package. Some employers prefer a package that creates a pot of money for the executive that grows over time, unlike a cash bonus that is easy to spend as soon as it is received. For example, rather than paying a $5,000 cash bonus every year, the employer can set up an investment account to which the company contributes $5,000 annually.
After five years, the executive has $25,000, plus any potential growth in the account. The growing account is more meaningful to a valued employee and the executive will appreciate the employer’s ongoing efforts to prove the company’s appreciation for the executive’s hard work.
These six design features can be created using a variety of strategies, including:
o The executive (section 162) bonus;
o The restricted bonus arrangement;
o Split-dollar arrangements;
o Nonqualified deferred compensation plans; and,
o Combinations of these strategies that customize the executive compensation package to better meet company and employee objectives.
If you are in the business markets, it is critical to become familiar with each of these strategies. You can assist your client effectively and, with the six points above, motivate your client into action.
Matt Witte is a Financial Advisor with Renaissance Financial Corporation in St. Louis, Mo. You can e-mail him at [email protected]. Bill Stark is an advanced marketing counsel for Securian Financial Group. You can e-mail him at [email protected]
There are a number of design features you can suggest to motivate the employer to implement a package