Deferred Compensation – How Does It Work?

These are some common remarks from disgruntled employees and unhappy business owners. What can be done to address them?

In the fast-paced working environment today where “human” assets are recognised as key to organisational success, many companies are finding it tough to attract and keep their valuable “human” assets. They are also caught in a dilemma – taking pains to mentor and guide an inexperienced employee into a polished “gem”, only to be poached by competitors with a deeper pocket in just a turn! How can companies retain the services of these valuable human assets for as long as possible?

Whilst at the same time, there are employees and minority shareholders that demonstrate loyalty to the company. How can they be suitably rewarded?

Today, we will delve into Deferred Compensation Planning, with attention to the retention of key employees, as well as explore some ways to create retirement income for employees.

To learn about the importance of the planning aspect, let us first look at the possible implications a business may suffer in the event of premature departure of its valued employees:

1. Employees see no reason to stay on in the company. They are paid as much as they work; there are no future benefits awaiting them.
2. Key or valuable employees do not lose out on anything should they choose to leave at any time. There is nothing to bind them nor create loyalty to the company.
3. Employees may leave the company. Worst still, they may even:
   • set up similar companies;
   • take with them other existing employees;
   • take the company’s client base; or
   • join rival companies.
4. Without valuable employees around:
   • potential business deals may be lost for good;
   • projects come to a sudden and abrupt halt, and may not be completed; and
   • deadlines may not be met.

Human assets can be broadly classified into employees and business owners. For employees, there are many ways to retain their services in the company. Some commonly adopted retention strategies are salary increment, additional year-end bonus, better welfare, employee share option schemes, comprehensive medical benefits etc. Another effective but commonly over-looked retention strategy is providing a contractual retirement programme for employees. Some of the advantages of funding an employee’s Deferred Compensation Plan are as follows:

1. Retention of key employee’s service till retirement;
2. Building of employees’ loyalty to the company by letting them know that the company cares about their retirement and for their family;
3. Funding solution ensures minimum impact to the company’s cash flow and profitability at point of employee’s retirement; and
4. Funding solution gives assurance to employees that the company has the ability to pay for their retirement gratuity, regardless of the company’s profitability at time of retirement.

For the case of the business owner, Deferred Compensation Planning ensures that the retiring business owner gets his/her well-deserved retirement gratuity.

Many businesses will choose to plough back their profits for the company’s expansion, but few make provisions to plan for retirement gratuity for a retiring business partner. Even employees get a planned retirement in some companies; thus, it is only fair that companies should have in place a contractual retirement programme for all directors of the company as well.

The benefits of arranging Deferred Compensation Planning for directors are:

1. It ensures that the retiring director will get some form of retirement gratuity for their many years of services with the company;
2. It ensures that the retiring director gets his fair share of the accumulated profits that have been reinvested in the company; and
3. Funds are available within the company to pay the contractual compensation.

With Deferred Compensation Planning in place, it is a win-win situation for the company and the employee. For the company, the employee will be committed to deliver the best work. For the employer, he/she is assured of a deferred compensation upon a certain number of years or upon retirement.