As we continue through the beginning of the year, many who are still tackling year-end to-do lists now also face the tasks of end-of-year reporting, employee evaluations, promotions and bonuses. However, the first quarter is also an opportune time to look at your bank’s deferred or executive compensation plans and reevaluate them if necessary. Most independent community banks offer some form of executive compensation, whether through long-term retirement/wealth accumulation plans or short-term incentive plans.
Long-term plans are typically designed to pay out after the executive has finished employment with the bank. They are considered “top hat” plans and are usually limited to the top 15-20% of employees based on compensation. Commonly known as Supplemental Executive Retirement Plans (SERPs) or Salary Continuation Plans (SCPs), these plans are designed to retain and reward the bank’s top executives by contractually promising a payout, or stream of payments, at the time of retirement.
While some plans are based on a percentage of final salary, others use a fixed amount instead. In such cases, they may need to be reevaluated every few years to determine if the contractual payment amount remains appropriate, especially for executives who may have received multiple promotions or raises over the years.
The most common short-term plans, rather than focusing on retirement, provide executives with deferred cash compensation while they are still employed at the bank. Commonly known as Deferred Cash Incentive Plans (DCIPs), they can be structured to award an employee an annual grant that may be based on a percentage of salary, or an amount determined by the bank’s performance (or the individual employee’s performance) via an annual scorecard. That grant is then deferred for some years (typically three to five) while earning interest. After the deferral period, the employee is paid the award plus interest.
These plans tend to be popular and effective with the second or third tier of employees who may have more immediate cash needs than a retirement plan would provide. As opposed to the SCP, these DCIP plans are not “top hat” plans and can be offered to everyone in the bank. If a bank is using the scorecard method, the annual scorecard should be determined by the first month or two of the year to provide employees with a clear understanding of the metrics that will affect their grant.
Deferred compensation plans are offered at a bank’s expense, and many banks with such plans utilize Bank-Owned Life Insurance (BOLI) as an indirect cost offset to these expenses. BOLI is a bank asset, where the bank is both the owner and beneficiary of the policy, generating earnings on a tax-preferred basis. Banks book tax-free earnings monthly, and if held until the contracts mature, all gains and death benefits of the BOLI policy are tax-free to the bank.
The spread between BOLI and other alternative assets determines the amount of excess funds the bank is earning, which can be used to offset the expenses of deferred compensation plans. A strategically designed plan can even generate excess earnings over the costs of executive compensation plans, which flow directly to the bank’s bottom line and its shareholders.
With a deep understanding of the BOLI market and a veteran team with over 100 years of combined experience, BCC specializes in tailoring efficient strategies to support banks’ individual policies and objectives. Don’t hesitate to reach out if you’d like to learn more.
