Incentive and Deferred Compensation

Providing incentive and deferred compensation gives you the opportunity to be creative and to go beyond the basics of an employee’s current salary. The goal is to attract, retain, and motivate key employees so that they choose and stay with your company, and are driven to help your business succeed through their skills and dedication.

Incentive programs

A good incentive plan should have measurable goals and specific rewards tied to achieving those goals. They should include a blend of corporate goals and those that the individual can help shape. The key employee must be able to make a difference and see how his or her actions affect the outcome.

Deferred compensation

Incentive programs can be tied to deferred compensation. Long-term rewards and delayed or deferred compensation can help provide key employees with further incentive to remain with your company longer. This can be tied to equity participation or partial ownership of your company, which aligns the interests of employees with those of the firm and its shareholders. Deferred compensation can be tied to stock options and a variety of other forms of compensation that are based on the company’s stock value rising. These include phantom stock and stock appreciation rights (see “Arranging Equity Participation”).

Corporate-owned life insurance

One way to fund deferred compensation effectively is through corporate-owned life insurance (COLI) – a life insurance policy that is owned and paid for by the company, with the key employee as the beneficiary. Once the employee retires, he or she typically begins receiving the deferred compensation, which is paid for by the COLI policy. As the insurance policy owner, the company may borrow against the policy, and even use the borrowed funds to pay the policy premium. Should the key employee (the beneficiary) die before retirement, the company would collect the death benefit.
But once payments are made to the employee in retirement, the company will receive tax deductions for those payments. And the employee must pay tax on the benefits as part of his or her gross income in non-qualified deferred compensation plan.

Game Plan

  • Find out how competitive your total compensation package is. Do some benchmarking and get your accountant to help.
  • Address any situations where your key employees are being under-compensated.
  • Discuss all incentive compensation tax issues with your accountant.
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