Choosing the Right Plan
The first option for many employers to consider when looking to create a plan that keeps their employees and top executives happy, is a Reward Program. A reward program can help an employer stay competitive in today’s challenging marketplace, as employees and executives are beginning to demand more than a traditional salary alone. This program can also allow an employer to “share” the growth of the company with the executive without necessarily giving them company stock. Using something other than company stock to share the growth prevents shareholder dilution from occurring, something that can be challenging to avoid when using a typical stock-based reward. While employees and executives may appreciate the benefits offered by this program, it does little to encourage long-term retention as most rewards are paid currently.
The second area that employers consider when creating a plan is a Retention Program. How does a company prevent their rainmakers and top talent from leaving the company and going to a competitor? Something that provides glue to their seat, or “Loyalty Velcro”, is needed for them to stay. Retention programs, or plans, are primarily focused on making sure the company’s best talent will not leave. These plans are also used as a recruiting tool, hopefully attracting new top talent to the company. Retention programs will usually promise to pay future benefits to the executive, with those future benefits having a longer vesting schedule. This longer vesting schedule make it difficult for the executive to leave, as they could be forgoing significant future benefits by doing so. Because of the long-term focus of these plans, communication is key once the plan is in place. It is recommended that the executive receives an updated plan statement at least once a year, this way they can be reminded of their future benefits while casting a vision of long-term employment with the company.
The third , an increasingly more common approach, is a Reward and Retention Program. We often call these IRR Plans, or Incentive, Retention, and Reward as they improve the overall IRR for the company as well. The goal of this plan is to create a program that will reward top talent for their productivity, while retaining that same top talent. There are two popular methods for rewarding and retaining executives, defined benefit plans and defined contribution plans. Defined benefit, as the title suggests, gives the executive a predetermined benefit that they are to receive in the future, assuming they remain with the company. Defined contribution, on the other hand, involves the company setting aside or contributing a certain amount for the executive now, without necessarily promising a particular benefit to be paid in the future. These contributions may be increased or decreased depending on different factors, such as company performance. Additionally, a more complex defined contribution plan may have the interest rate tied to key performance indicators within the company. A defined contribution plan such as this will be more complex than a standard defined benefit or contribution plan, as it combines the best of both. All three plans require legal documentation and a third-party administrator (TPA), but a more complex plan may need additional monitoring to accurately determine the contributions and amount of interest that should be accredited for a given period.
The second area that employers consider when creating a plan is a Retention Program. How does a company prevent their rainmakers and top talent from leaving the company and going to a competitor? Something that provides glue to their seat, or “Loyalty Velcro”, is needed for them to stay. Retention programs, or plans, are primarily focused on making sure the company’s best talent will not leave. These plans are also used as a recruiting tool, hopefully attracting new top talent to the company. Retention programs will usually promise to pay future benefits to the executive, with those future benefits having a longer vesting schedule. This longer vesting schedule make it difficult for the executive to leave, as they could be forgoing significant future benefits by doing so. Because of the long-term focus of these plans, communication is key once the plan is in place. It is recommended that the executive receives an updated plan statement at least once a year, this way they can be reminded of their future benefits while casting a vision of long-term employment with the company.
The third , an increasingly more common approach, is a Reward and Retention Program. We often call these IRR Plans, or Incentive, Retention, and Reward as they improve the overall IRR for the company as well. The goal of this plan is to create a program that will reward top talent for their productivity, while retaining that same top talent. There are two popular methods for rewarding and retaining executives, defined benefit plans and defined contribution plans. Defined benefit, as the title suggests, gives the executive a predetermined benefit that they are to receive in the future, assuming they remain with the company. Defined contribution, on the other hand, involves the company setting aside or contributing a certain amount for the executive now, without necessarily promising a particular benefit to be paid in the future. These contributions may be increased or decreased depending on different factors, such as company performance. Additionally, a more complex defined contribution plan may have the interest rate tied to key performance indicators within the company. A defined contribution plan such as this will be more complex than a standard defined benefit or contribution plan, as it combines the best of both. All three plans require legal documentation and a third-party administrator (TPA), but a more complex plan may need additional monitoring to accurately determine the contributions and amount of interest that should be accredited for a given period.
Funding Options
Executive benefit plans typically have three funding options. The first option is the unfunded plan. This means that the company simply promises to pay the future benefit to the key executives when that time comes. The company does not set aside any funding to help cover that future liability. This method leaves executives feeling vulnerable as they can only rely on the good faith of the ownership of the company to pay them in retirement. An extremely small percentage of all plans nationwide are unfunded or “naked”.
The second option of funding is through investments, like mutual funds. This is funded by the company and set aside in an account to cover the future benefit distribution. This allows the executives to know that there is money set aside to pay those future benefits. This method is not commonly practiced however, because of the tax issue. The corporation will have income taxes to pay as these funds are taxable each year as they grow. There is also a significant downside to this approach. If distributions to the executives are occurring when there is a significant drop in value due to a market correction, it leaves the executives feeling unsafe and the corporation wondering if they will have to add additional funds to keep up with the market adjustment. Only a small percentage of all plans nationwide use this method.
The third funding method, and the most common, uses Corporate Owned Life Insurance (COLI) to informally fund the benefits promised. The benefits of using COLI are efficiency and cost recovery. The efficiency comes in the large general account portfolios of insurance carriers that achieve a stable rate of return year after year. The other efficiency comes in the tax deferred and tax-free nature of how life insurance works. The cost recovery side is a direct result of the death benefit coming back to the company as the company is the owner and beneficiary of the policies. This death benefit is received tax-free, and most times recovers all the costs that were ever paid out to the executive for the benefit plan. If properly structured, COLI will not only recover the cost of benefits, but create the opportunity share some of the death benefit with heirs or charities while improving earnings on the balance sheet.
The second option of funding is through investments, like mutual funds. This is funded by the company and set aside in an account to cover the future benefit distribution. This allows the executives to know that there is money set aside to pay those future benefits. This method is not commonly practiced however, because of the tax issue. The corporation will have income taxes to pay as these funds are taxable each year as they grow. There is also a significant downside to this approach. If distributions to the executives are occurring when there is a significant drop in value due to a market correction, it leaves the executives feeling unsafe and the corporation wondering if they will have to add additional funds to keep up with the market adjustment. Only a small percentage of all plans nationwide use this method.
The third funding method, and the most common, uses Corporate Owned Life Insurance (COLI) to informally fund the benefits promised. The benefits of using COLI are efficiency and cost recovery. The efficiency comes in the large general account portfolios of insurance carriers that achieve a stable rate of return year after year. The other efficiency comes in the tax deferred and tax-free nature of how life insurance works. The cost recovery side is a direct result of the death benefit coming back to the company as the company is the owner and beneficiary of the policies. This death benefit is received tax-free, and most times recovers all the costs that were ever paid out to the executive for the benefit plan. If properly structured, COLI will not only recover the cost of benefits, but create the opportunity share some of the death benefit with heirs or charities while improving earnings on the balance sheet.
Deciding the "Who" and the "What"
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Now that we have discussed the basics, it is time to decide the “who” and the “what”. Who on your team can’t you afford to lose to a competitor? Who do you want to reward for helping to grow the company without dilute shares of the company? After you decide who you want to create a benefit for you need to decide what benefit has the most meaning to the corporate growth and the executive's benefit. Click on the PDF to the right to download a decision flow chart to aid in figuring out how to design the best plan for your company. We are at your service to walk you through the flow chart to create a bespoke plan for your company.
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