A New Approach to Signing and Retention Bonuses

As workers’ expectations evolve and workplace dynamics shift, the functionality and opportunities of signing and retention bonuses are also changing. Instead of giving employees a lump sum payment (cash compensation) either initially or waiting 2-3 years to reward them upon their retention date, some employers use deferred compensation plans strategically to reward their employees immediately.

What Is the Recommended Length for the Retention Period?

In today’s workplace environment, many companies tell our nonqualified deferred compensation team that rewarding an employee on vesting schedules of 10 years or more does not provide the immediate gratification necessary to retain the employee. Companies report that employees often leave unvested money on the table in pursuit of more immediate financial opportunities.

In response to this workplace trend, many clients we serve successfully use a 3-year vesting schedule for deferred compensation to reward and retain key employees.

How Can Deferred Compensation Plans Play a Role in Signing and Retention Bonuses?

Deferred compensation plans may offer an effective solution for retaining key employees. By deferring awards into a deferred compensation plan, participants can invest their unvested awards today and participate immediately in market activity.

Risk-averse employees can invest their awards conservatively, selecting investments that align with their risk tolerance. As the awards step up and become vested, the portion of the balance that vests will be subject to Federal Insurance Contributions Act (FICA) taxes (Social Security and Medicare taxes). However, participants receiving these awards may already be above the Social Security income wage, which in 2022 is $147,000, and would not be subject to the 6.2% Social Security tax.

Why does a deferred compensation strategy make sense?

1. Employees often find a vesting time horizon of 3 to 5 years more tangible than longer-term vesting schedules. They tend to like the opportunity to invest their unpaid bonuses pre-tax, and they value the potential opportunity to grow their awards on a tax-deferred basis.
2. Employers say they like not having to hand over immediate cash and see the value in avoiding the risk of clawing back funds should the employee fail to meet the minimum retention timeframe.

What Are the Options for DCP Distribution?

Deferred compensation plans can provide flexibility for any employee or candidate. Younger employees or employees with immediate needs or goals might use their awards quickly to fund short-term financial goals such as buying a car, a home, or paying student loans. Their award payout through a scheduled in-service payment would allow them, as plan participants, the quickest access to the funds. In this scenario, the award plus any gains or losses would be paid out to the employee once the award is fully vested.

Participants approaching retirement frequently choose to keep their awards invested inside their deferred compensation plan. Their objective is to have their award supplement their retirement income when they eventually leave the company. Most plan administrators will allow participants to allocate their award into an in-service account, a retirement account, or both.

A Creative Approach to Signing and Retention Awards

Structuring a signing or retention award effectively can mean the difference between landing the right new hire or retaining a valued employee. Focusing on employees’ short-term and long-term financial well-being is always in a company’s and the employee’s best interest.

When working with clients, our team sees that the combination of both immediate and deferred awards creates positive outcomes for the organization’s recruiting and retention initiatives.

Example of a Combined Approach to Attract Top Talent and Retain Key Employees

Why Does the Combination of Immediate and Vested Deferred Compensation Work?

Offering half an award upfront gives the employee or prospect immediate financial gratification. Investing the other half into the deferred compensation plan, allowing it time to vest, sends the clear message that the employer is interested in keeping the employee long-term.

Allowing the plan participant to invest and grow the balance tells the employee that the employer is committed to their long-term financial well-being. Additionally, should employees leave the company before reaching their retention period, it’s much easier to forfeit the second half of the award rather than attempt to claw back the amount from the employee.

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This article was written by Sam Robert, Vice President – Retirement, OneDigital Company. Sam Robert has more than twenty years of financial services experience, much of which has been focused exclusively on executive benefits and nonqualified deferred compensation plans.