Recruiting and retaining key talent is critical to building a company’s value and thus your legacy.
This article will outline:
- Who is a Key Employee?
- What is an Effective Retention Plan?
- What Types of Plans are there?
- When is the right time to implement a plan?
Who is a Key Employee?
Employees are motivated for typical reasons (work culture, pay/benefits, job security, etc.), key employees are different; many times, they act as a proxy to you and your goals. They tend to take responsibility of the company’s well-being, its customers, its industry, its vendors, etc. They also offer meaningful input for you to improve the business. Key employees are known in their industry. Many times, they are a focus of competitors for hiring away, especially given today’s limited talent pool.
What is an Effective Retention Plan?
As an owner, you know that an environment where talent thrives is a winning formula. The typical answer we hear when we ask the question “How are you retaining your key employees?” is “I pay them well”. Unfortunately, simply paying people more does little to prevent competitors from offering higher pay, nor does it necessarily encourage these key employees to continue to develop leadership skills to assist you in growing the business. In addition, depending on the state you live in, regulatory factors often prevent you from singling out these key employees for additional benefits to stay.
This is where a properly designed key employee retention plan comes in. These plans encourage productivity and loyalty. They also allow you to handpick the participants, are subject to minimal IRS intervention, and have no mandates on minimum or maximum contribution amounts. When designed properly, these plans pay for themselves.
Any retention plan that is considered, needs to have a Benchmark, Benefit, Payout, and Communication.
As you well know, providing a target to hit creates its own incentive for your employees. Alone, a Benchmark is essentially a goal to hit. Sales employees sometimes gain additional compensation going above and beyond their peers. For a key employee, common benchmarks are based on company profits, team profits, revenue growth, or savings. On occasion, the benchmark is simply a time or vesting schedule in which an employee must stay with the company for a certain amount of time to receive this benefit.
The Benefit is always compensation of some kind. This Benefit needs to be substantial in the eyes of the participant. It is separate from a bonus or standard compensation. Usually, this Benefit is 100% of one year’s compensation to be paid out following the achievement of the benchmark and the vesting period.
The Payout is a key function of the retention plan. A percentage (if not all) of the benefit must be deferred to some future date. Having no future payout tends to be where most employee retention plans fail. Financially astute key employees most likely understand the benefit of deferring additional dollars, especially if their participation in the company qualified plans is capped.
As with all plans, Communication is key. Each plan needs to be provided to the key employee in the form of a written plan summary. While this seems obvious, many times this piece of communication is over-looked. The key employee must understand why they are being offered this plan, how it works, and what the terms to the plan are.
What types of plans are there?
There are two different types of retention plans – Cash or Stock.
Cash based plans are the most used, particularly in closely held small to mid-sized companies.
Supplemental Executive Retirement Plan (SERP)
With this plan design, the company provides supplemental retirement income paid out of the cashflow from the company. If the key employee passes away, the company owned life insurance is used to recover the cost of the plan and provide a benefit to the designated beneficiary. Benefits are taxed upon receipt of the funds and tax deductible to the company when paid.
Nonqualified Deferred Compensation Plan (NQDC)
A Nonqualified Deferred Compensation plan enables key employees to defer compensation on a pre-tax basis, typically in addition to qualified plan limits. There is more administrative complexity with these sorts of plans. As with the SERP plan, the benefit is taxed when received and deducted by the company when paid.
Restricted Executive Bonus Arrangement (REBA)
Under this plan, the company deposits bonuses into a life insurance policy for the benefit of the key employee. The tax-deferred nature of this plan provides the employee with a source of tax-free income as well as a tax-free benefit in the event of premature death. The key employee owns the policy and names the beneficiary, but has restrictions placed on the cash values until the Benchmark or Payout is met. Because the key employee owns the policy, the bonuses are considered taxable income when paid to the plan and the company receives a deduction for paying the bonus to the policy.
Stock Based Plans
When considering stock as a benefit, you should ponder whether you are looking for a partner or just wanting to reward your key personnel. On occasion, if the key employee is an ideal fit to succeed you, a stock incentive plan can assist the key employee in financing the purchase of the business.
Conclusion: Now is the time to review
As an owner, you should explore a retention plan for your key employees. With a tight labor market, competitors are looking to hire your key people away. You should also consider your future and whether these key people will be successors in the business – if so, a plan as described above may be an ideal solution to increase the likelihood of a successful transition.
The effect to your business should these key people leave would be drastic.
For more than 20 years, RMA has help privately held businesses retain top talent through the creation of key employee retention plans. Free of charge, we will assist you in reviewing the options and the effect they will have on the legacy of your business. If you’d like to learn more about these programs, please contact us at the number or email below.
Written by,
Zebadiah Wade