Simply through their sheer numbers, the baby boomers have managed to change the rules about how many industries do business and the retirement industry is no different.
The boomers have overwhelmed pension systems and Social Security and the mass exodus of older workers has left many corporations with talent gaps at the top.
One thing that hasn’t been adequately addressed is retirement vesting provisions, say Susan O’Donnell, partner for financial services at Meridian Compensation Partners, LLC in Boston, and Shane Meredith, a senior consultant for Meridian in Lake Forest, Ill., who believe more corporations need to take a closer look at how they incentivize executives to make sure they continue to serve the needs of the company until the day they retire and, in some cases, beyond.
One of the largest elements of executive compensation currently is equity incentives or long-term incentives.
Also see: “The power of incentives in retirement plans.”
“These incentives were intended to create ownership alignment or are used as a retention instrument,” says O’Donnell. “Retirement plans can serve as a retention instrument as well. They are on the same side with compensation, with similar but different goals.”
Equity incentives reward performance while retirement plans are a benefit.
“Benefits and compensation programs are tied together. If you retire, you will lose your equity. So what ends up happening is that it can influence the wrong behaviors. It encourages people to stick around who otherwise would want to retire,” she says.
That can have a negative impact on a company’s succession planning and an executive’s motivation to continue doing a good job for the company.
O’Donnell recalls one executive client who wanted to retire and gave a lot of notice that he was leaving because he felt it was the right thing to do. But because of that notice, he was ineligible for his final payout of equity incentives. If he had given his company only two, instead of six, months' notice he would have retired with his full benefits.
But organizations are becoming more strategic on this issue, says O’Donnell.
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“You want to continue to motivate people to and through retirement. You want to encourage them to build succession and do the right things in their last years [before retirement],” she says. “It is a fairness issue. You are giving them rewards and they may not ever receive them.”
For many large publicly traded companies that offer equity incentives, these may be a huge chunk of employees’ retirement wealth accumulation, so how the vesting provisions are worded can have a major impact on outcomes.
Most companies use forfeit, which means that employees earn at least a portion of their incentive before they retire but forfeit the rest if they haven’t met all the requirements.
Full acceleration means that executives receive the full amount of their equity incentives when they retire, which, Meredith points out, is not necessarily a great incentive for retention.
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There are two ways to structure vesting provisions to ensure that employees continue to work toward the company’s long-term goals, even when they are near retirement. Continued vesting is an emerging practice that would allow executives who truly retire to continue on their current vesting schedule into retirement as long as they agree to actually retire and not retire across the street to a competitor.
If an executive retires in 2016, but their equity incentives aren’t fully vested until 2017, they would still get those incentives in 2017 as long as they retire, Meredith explains. This motivates people to do their best for their employer up to and into their retirement.
Committee discretion is another option that is gaining in popularity but is still very rare. This allows benefits committees to decide on a case-by-case basis how these incentives are paid out. But most “committees don’t want that level of responsibility,” Meredith says.
Many retirement provisions have unintended consequences that nobody thinks about because the programs are old and have always been done that way.
“Nobody thinks about it until something happens, something triggers it,” O’Donnell says.
The baby boomers have triggered more conversation about the topic of retirement vesting provisions because so many of them are reaching retirement age at the same time.
Many corporations have frozen or closed their defined benefit plans so many have turned to other forms of compensation, like equity, to retain skilled employees.
“With these provisions, nobody took a step back to look at how it would all evolve,” O’Donnell says.
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Because of the baby boomers, companies have had to take a closer look at succession planning and leadership development, and retirement incentives and benefits all figure in to how those play out. If the vesting provisions aren’t crafted correctly, executives could abruptly leave after collecting their equity incentives without caring much about what happens to the company and their position when they leave.
“The value of equity has changed. It has changed by industry and economic cycle, but that’s why every company has to sit back and look at their employee base, what they are trying to accomplish and the succession issues,” O’Donnell says.
Paula Aven Gladych is a freelance writer based in Denver.
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