Board of directors, do you recognize the importance of executive compensation? Providing powerful compensation incentives is what sets you apart in the hiring and retention game. At Newcleus, we design deferred earnings packages that bring value and envious returns on your investment in your people. Properly designed executive compensation plans aid in retaining your top talent and senior leadership. So, board of directors, here is your deep dive into executive compensation.
What is Deferred Compensation?
Deferred compensation, which is often crafted for company executives, is “a portion of an employee’s compensation that is set aside to be paid at a later date… Forms of deferred compensation include retirement plans, pension plans, and stock-option plans,” according to Investopedia.
Why Deferred Compensation?
Did you know that 56% of credit unions with assets over one hundred million reported that their CEO has a non-qualified compensation plan? This number continues to grow as deferred compensation plans grow in popularity.
These compensation plans are tools used by employers to retain top talent or senior executives. In fact, the majority of credit unions (80%) with over $1 billion in assets use deferred compensation plans. Remember, the cost of losing a key executive or top employee is very expensive. Deferred compensation plans are a great way to avoid this pitfall while benefiting both the employer and employee.
Most credit unions utilize deferred compensation as an executive retention tool. Others state that higher retirement benefits, succession planning, recruitment tools, and other qualified retirement plans fall short as reasons for choosing non-qualified deferred compensation plans.
The Three R’s
- Recruit: A competitive deferred compensation plan can be a significant piece to attract new talent. Credit unions nationally are including deferred compensation plans when hiring new executives. To remain competitive and hire the best people you need to be offering deferred compensation.
- Reward: Reward your key talent for high performance.
- Retain: Retain key talent to stay with the credit union and help them perform into the future!
A final note: One of the most attractive features of properly designed compensation plans is that they can be highly customized and tailored to an individual or company. This considered, plan designs change over time. In fact, multiple designs and plans can be used for a single executive.
The Decision-Making Power
According to The Atlantic, after totaling salary, bonuses, and stock-based compensation, “in 2014, 500 of the highest-paid senior executives at U.S. companies made nearly 1,000 times as much money as the average American worker.”
The weight of this statistic brings us to the question: Who decides how much these top executives are being compensated? Carmen Nobel wrote for Forbes, “for years I imagined this group of people sitting around a table, having to… [define] the CEO’s compensation package… What is the information they use? What are the questions they ask? And more specifically, what are the sources of influence on the decisions that they make?”
The faces behind these decisions include the board of directors, who typically rely on input from their compensation committee and compensation advisors, who the compensation committee typically hires, according to Harvard Law School.
This team works together to benchmark an executive’s compensation through a comparative analysis of competing companies and by looking closely at the economy of capital, earnings, and benefit provision to create the optimal plan. Plan design framework is also largely influenced by IRS guidelines and applicable regulations. Regulators, in turn, drive much activity regarding plan structure. It is important for all parties to understand the embedded risks of each plan.
Executive Compensation Plans: A Brief Breakdown
Like a snowflake, no two compensation plans are the same. When it comes to compensation design and packaging, there are a variety of benefits that can be bundled together—all with varying attractiveness and effectiveness. Most commonly, however, executive compensation plans, at the least, consist of these elements:
- Base salary (cash compensation)
- Short-term incentive or incentive compensation (immediate objectives – i.e. an annual bonus)
- Long-term incentive (intermediate deferred compensation)
- Supplemental Employee Retirement Plan (SERP)
- Additional benefits and perquisites
One can read more about executive compensation design here.
Plan Types
Firstly, it’s important to know that deferred compensation plans can either be qualified or non-qualified.
The majority of non-qualified deferred compensation plans being utilized today are 457(f) SERP plans at 56.1%. Credit unions of all asset sizes are utilizing these deferred compensation plans. These plans offer enticing retirement benefits for the executive, while also being fiscally responsible and easily defended for the credit union. More recently, however, credit unions are moving toward 457(f) rather than 457(b) in favor of the flexibility in design and greater retention rates.
It’s important to note that smaller credit unions are also utilizing collateral assignment split-dollar plans. This is likely related to the fact that collateral split-dollar plans largely depend on the CEO’s compensation level. Insurance companies apply underwriting limits when determining the amount of insurance any single executive can receive. Insurance underwriting limits the amount of insurance carried under one executive, which, in turn, makes it a less competitive option for larger credit unions.
Qualified deferred compensation plans comply with the Employee Retirement Income Security Act (ERISA). This means they include plans like a 401(k) and 403(b). These plans are required to have contribution limits and are open to any employee in the organization. These plans typically feel more secure for users, as they are held in a trust account.
Non-qualified deferred compensation plans, on the other hand, are written agreements between the credit union and the employee. In these plans, part of the employee’s compensation is withheld by the company, invested, and then given to the employee at some point in the future. Non-qualified deferred compensation plans do not have contribution limits and can be targeted at certain employees in your organization, such as your executive team. With these plans, it’s important to note that the deferred money is part of the business’ funds, so it is subject to the same risk the business is associated with.
Executives are typically driven to one or the other often based on their own tax situation. Examples of a non-qualified plan include 162 executive bonus plans, equity regime split-dollar, loan-regime split-dollar or collateral assignment, 457(f), 457(b), and more.
Supplemental plans include disability insurance and life insurance. Group plans, however, have limits and highly compensated executives will be past those limits. They are additionally designed to help cover the gap of the caps that the group plan implements.
How We Create Value at Newcleus
Regardless of the unique plan that your board of directors creates for an executive, there are three components in any executive compensation plan: plan design, plan funding, and plan administration. Remember, design is a means to the end. The plan objective is the end.
At Newcleus, we recognize that understanding deferred compensation can be challenging. To begin this deep dive into deferred compensation, it’s important that you return to the objective of your plan. We specialize in designing deferred earnings packages to retain your top‐tier people, making sure they’re paid appropriately while maximizing the return your institution provides to your members. Contact us today to learn more!