Retaining Talent Through Retirement Plans and Deferred Compensation

Dean Johns, CPA, John D. Dovich & Associates

With unemployment at historic lows, business owners are faced with significant challenges while trying to attract the talent that will allow them to continue growing their business.  However, retaining key talent is even more critical to avoid the disruption caused by having to replace key talent.  There are many strategies around retention involving culture, workplace environment, challenging work, etc.  We will explore how the utilization of retirement and deferred compensation plans may provide the right financial incentives to retain your key talent.

A high-quality 401(k) plan is the most basic retirement plan that a company must have in today’s environment.  Surprisingly enough, many companies still don’t have a basic safe harbor plan to allow its highly compensated employees (i.e.: key talent) the opportunity to maximize their annual deferral contribution limits.  We often see plans that fail non-discrimination testing, which results in excess contributions being returned to key talent, and key talent not having the opportunity to contribute the maximum limits to a retirement plan.  The plan should also have reasonable fees, as well as a diversified menu of high-quality investment options.  If your key talent can’t achieve their long-term financial goals through the most basic of retirement plans with you, they will likely find another employer that will allow them to do so.

Again, with the idea of retaining key talent, owners should also consider utilizing the profit-sharing component to the 401(k) plan that is tied to the goals and objectives of the company.  Oftentimes, businesses simply share their profits via cash bonuses.  Obviously, a bonus is a nice immediate reward but is it the most tax-efficient way to reward your employees?  And does it provide an incentive to stay on board via a vesting schedule?  Many of the key talent will be “highly compensated” under the retirement plan definition/rules which allows for flexibility and discretion with regards to how you reward your key talent, as profit sharing allocations do not always have to be uniform if the plan is designed properly and assuming the key talent qualify as highly compensated individuals.

With the idea of providing the opportunity for even more qualified plan contributions you might consider a defined benefit plan (i.e.: a cash balance plan).  Many individuals believe that so-called “pension plans” are a thing of the past.  While many of the large company pension plans have been frozen or terminated, for small private or family-owned businesses, defined benefit plans can be very powerful and extremely tax-efficient.  It is important though to have the right retirement plan consultant and actuary structure the plans appropriately based on the goals and objectives of the owner(s), all the while making sure it is harmonious with the existing 401(k)/profit sharing plan.

All of the plans mentioned above are qualified ERISA plans.  Each of them has their own set of complex rules that must be followed to achieve tax efficiencies while providing for creditor protection of the plan assets.  Another type of “retirement” plan to consider is a non-qualified plan.  One such variation is a deferred compensation arrangement.  These plans can be tailored to your key talent individually such that they are directly impacted by metrics relative to their role and/or goals, as well as the goals of the company.

Additionally, vesting schedules are oftentimes applied to deferred compensation plans to provide a financial incentive for key talent to stay on board, which is obviously a goal of the owner(s).  We do find that for these plans to be successful though, the amount earned each year through deferred compensation must be meaningful – typically at least 25 percent of the key talent’s annual compensation.  Otherwise, your key talent won’t see enough value in the plan to resist an offer to move elsewhere.

We also recommend that these plans be funded, as opposed to the benefits “accruing.”  The benefits must feel “real” to your key talent or the key talent will not recognize the value a deferred compensation plan can and will bring to them.  You should also consider your key talent having a say in how the funded assets are invested.  Again, it helps for the key talent to feel as though the deferred compensation is theirs even during a vesting period.

Finding talent is hard enough.  Once the talent is on board, focus your efforts on utilizing various retirement plans to provide the financial incentives necessary to retain it.

John D. Dovich & Associates is a Federally Registered Investment Adviser. Registration as an investment adviser does not imply a certain level of skill or training.  The oral and written communications of an adviser provide you with information about which you determine to hire or retain an adviser.