Use Employee Compensation Plans to Keep Your Valued Employees
As many employers have discovered, it is becoming increasingly difficult to attract and retain talented employees. One method is to provide an attractive deferred compensation plan for your key employees.
Deferred compensation plans may be of two general varieties – “qualified” or “non-qualified”. In a qualified plan, such as a profit-sharing plan or a 401k plan, there are various laws regarding the terms of those plans. These terms may include who is eligible to participate, vesting schedules, and the permitted amount of annual contributions. In these plans, the employer receives an income tax deduction when it makes a contribution to the plan. The employee includes in its income the amount it receives from the plan upon distribution. If the employee leaves the employer, the employee may take all vested amounts.
In “non-qualified” plans, the governing laws are less rigid in terms of eligibility and other terms of the plan. The employer may choose who may participate, provided the employer does not discriminate based on protected classes, such as race and gender.
In a non-qualified plan, the employer may add different vesting schedules and include non-competition provisions, as well as other provisions intended to encourage the employee to remain in the employ of the employer. In non-qualified plans, the employer is entitled to an income tax deduction when the employee is required to include the amounts in its income.
Some of the more common provisions in non-qualified plans include the following:
- Vesting- The vesting schedule could be as long as the employer feels is necessary. Practically speaking, it should not be so long that the employee does not “see” the benefit in remaining with the employer.
- Incentives- The contribution could be dependent on the business attaining certain revenues or profits.
- Payouts to Employee- Amounts could be payable to the employee upon the employee’s death, disability, or retirement at a certain age. Payments could be made over a period of time (e.g., monthly over five years) and can be tied to certain restrictive covenant periods.
- Non-Competition- The employee would agree not to compete with the employer after termination of employment.
- Payments Upon Sale of Business- The plan could be structured so that the employee would receive payments upon the sale of the business. Often these types of plans issue “phantom equity” to the employee. This “phantom equity” has no voting rights or any other rights that an equity holder might have. However, the “phantom equity” has a value attributed to it, and that value is paid to the employee upon the sale of the business.
While many employees expect that the employer will have a “qualified plan”, a qualified plan does not provide an incentive for the employee to remain employed with the employer because the employee may leave at any time and take all vested benefits. With a “non-qualified plan”, the employee is provided an incentive to remain with the employer. If the employee leaves “early”, then he or she may forfeit any benefits which would have been provided.