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Definition:
Deferred compensation refers to an arrangement in which a director's compensation is delayed, typically until retirement or after leaving the board. This compensation is often in the form of stock options, restricted stock awards, or other long-term incentive plans. The purpose of deferred compensation is to align the interests of the director with those of the company, as they are incentivized to make decisions that will benefit the company in the long-term, rather than solely focusing on short-term gains. Deferred compensation can also provide tax advantages and can help to retain and attract talented directors.
As a member of a board of directors, your role is crucial in shaping the direction of your organization. One aspect of your responsibilities may include offering deferred compensation to board members. This compensation allows board members to delay receiving a portion of their pay until a later date. In this article, we will explore the basics of deferred compensation, the role of the board of directors in offering it, the pros and cons of offering deferred compensation to your board members, tax implications, how to design a deferred compensation plan, best practices for administering it, how to evaluate its success, case studies of successful implementation, and common mistakes to avoid.
Deferred compensation is a form of payment set up to delay a portion of a board member's pay until a specified date. This type of compensation can come in many forms, including supplemental retirement plans, salary deferral plans, and bonus deferral plans. This compensation method benefits board members by offering flexibility in how they receive their pay, allows them to defer taxes, and provides a benefit for staying on the board for an extended period.
When a board member agrees to a deferred compensation plan, they are essentially agreeing to delay a portion of their pay until a later date. The deferred payment is typically invested in a tax-deferred account, allowing the board member to delay paying taxes on the income until the funds are withdrawn. Typically, the funds are not available until the board member retires or reaches a specific milestone, like a specified number of years on the board.
The role of the board of directors in offering deferred compensation is to provide oversight and ensure that the deferred compensation plan is designed to meet the needs of both the board members and the organization. The board must work with a financial advisor to establish the plan's terms and ensure it aligns with the organization's goals and mission statement. Additionally, the board must work with the organization's legal and financial experts to establish a plan that is compliant with state and federal regulations.
The benefits of offering deferred compensation are numerous. Firstly, it allows board members to have more control over their finances by choosing when they receive their pay. It also incentivizes board members to stay on for a more extended period and rewards them for doing so, leading to stability and continuity in the board's governance. However, offering deferred compensation also has its drawbacks. It can be costly to the organization and may require ongoing administration to ensure compliance.
Tax implications for board members receiving deferred compensation can be complex. The deferred payment is not included in the board member's taxable income until it is paid out, which can delay payment of taxes until a later date. However, when the payment is received, it will be taxed at the current tax rate, which may be higher than the rate when the board member initially earned the income. It is essential to work with a financial advisor to ensure compliance with applicable tax laws.
The design of a deferred compensation plan should be based on the organization's goals, mission statement, and the board member's interests. The plan should include clear guidelines on eligibility, vesting, and payout schedules. The board should work with a financial advisor to determine the appropriate contribution limit. The plan should also address the organization's insurance and liability coverage and compliance with state and federal regulations. It is essential to communicate the plan to the board members clearly and ensure they understand its benefits and limitations.
Administering a deferred compensation plan requires ongoing monitoring and attention to detail to ensure compliance. Best practices include regularly reviewing the plan's terms, including eligibility and payout schedules, providing regular communication to board members regarding the plan's performance and their vested benefits, keeping accurate records and ensuring timely tax reporting. Additionally, the board should work to ensure that the plan is structured in a way that minimizes the organization's liability and risk.
The success of a deferred compensation program can be evaluated by measuring its impact on the organization's stability, continuity, and board member retention. Additionally, the program's financial performance and compliance must be regularly monitored. The board should work with a financial advisor to analyze the program's performance and make any necessary adjustments to ensure its continued success.
Several organizations have successfully implemented deferred compensation plans for their board members. One case study involves a non-profit organization that wanted to offer a deferred compensation plan to their board members to incentivize and retain their most effective members. The organization worked with a financial advisor to design a plan, establish clear guidelines, and communicate the benefits to their board members. The program was successful in incentivizing members to stay on longer, leading to long-term organizational stability and continuity.
It is crucial to avoid common mistakes when offering deferred compensation to your board members. Mistakes can include failing to properly structure the plan to meet compliance requirements, overcommitting the organization's financial resources, and failing to communicate the program's benefits or limitations adequately. Additionally, it is essential to work with experts to ensure compliance with applicable laws and regulations.
Offering deferred compensation to board members can be an effective way to incentivize and retain the organization's most effective members. A well-designed and appropriately executed plan can lead to a stable and long-term board governance structure. It is crucial to work with financial, legal, and tax experts to ensure compliance with state and federal regulations. Additionally, the program's compliance and performance must be regularly monitored and evaluated to ensure continued success.
