Compensation Arrangements Based on the Life Cycle of your Business

January 31, 2022

Even in the best of times, organizations struggle to design and implement compensation (defined as pay and retirement benefits for our purposes) arrangements that attract and retain top talent. The current COVID influenced job market has only exacerbated those struggles. Even though employee satisfaction with their position is driven by many new factors, compensation remains the primary driver for attracting, retaining and rewarding employees. There are many “tools” available to employers to assist with achieving their goals. Each provides different benefits and corresponding costs. They also can have vastly different regulatory requirements that impact their effectiveness and practicality given the growth stage of the organization.

Aronson’s “Compensation and Retirement Benefits Timeline” is designed to assist employers in understanding the available arrangements and the general feasibility based on their growth stage. A general description of the compensation categories is below:

Bonus Arrangements

Bonus plans are designed primarily to provide immediate rewards to employees. They are also often the least effective in retaining employees while also providing limited retirement benefits depending on the employee’s personal spending habits. Employees love cash rewards. These arrangements are also the easiest to administer with full employer discretion as to “who gets how much.”

Broad Based Retirement Plans

These are your typical employer sponsored retirement plans. The most common being the 401(k) plan whereby the employee and the employer contribute to the employee’s retirement account. However, there are also lesser known plans that can be very effective. Some of these include enhanced 401(k) plans, pension plans, and simplified employee pension plans “SEPs”. All of which have a unique place in the compensation framework.

These plans provide opportunities for current year tax deductible contributions but come with an additional regulatory and administrative burden. They are very attractive to employees because employee and employer contributions can be tax deferred. In the overall compensation structure, qualified retirement plans generally provide the least amount flexibility when trying to target benefits to specific employees.

Deferred Compensation Arrangements

These arrangements are non-qualified plans, meaning that “contributions” don’t receive a current year’s tax deduction and are not subject to the rigid regulatory framework typical with broad based retirement plans. They really are nothing more than a promise to pay employees compensation in the future and can be a great tool for employee retention. These arrangements provide benefits to only a select group of upper management and can be designed to provide different benefit amounts to different employees. While non-qualified plans can escape the regulations associated with qualified plans, they are often subject to the complicated rules of IRC 409A. The 409A rules can very confusing for employers and vendors alike with missteps subjecting the employee to harsh tax penalties.

Stock Compensation Arrangements

These compensation arrangements are tied to the value of the company’s stock and usually have characteristics of some of the arrangements detailed above. Stock options, stock purchase plans, and synthetic equity arrangements are common structures used to tie compensation to the value of a company’s stock. In some instances, employees are compensated with actual stock of the employer. These arrangements can have complex tax and accounting considerations and are often poorly understood by the employees.

The analysis associated with evaluating the various options for compensating employees can be daunting. This analysis is further complicated by unclear employee “wants”, available investment products and an overall lack of understanding of the regulations associated with the various  arrangements. Aronson’s timeline is designed as a starting point for beginning the evaluation process.

For more information on the costs and benefits associated with compensation arrangements, please contact Mark Flanagan of Aronson’s Compensation and Benefits Practice at 301.231.6257.