Q&A: Long Term Incentive Plans (LTIP)

What is a Long Term Incentive Plan?

An LTIP is an incentive bonus plan that makes payments based on the achievement of specific goals. Generally, these payments are paid three to four years after they have been earned and after satisfying the vesting requirement.

Which types of businesses can implement an LTIP?

LTIPs are used at both public and private companies. Companies will implement an LTIP in order to promote the achievement of specific goals that the board would like to promote. For private companies, these bonus amounts could be used to mimic the upsides of equity plans offered at public companies. By having payments paid at a future date the goal achievement can be over a longer period of time, and by tying the payments to a vesting schedule it provides a retention aspect to the executives.

Who should participate in an LTIP?

Because an LTIP is a type of nonqualified plan, a company must select the group of eligible participants within the guides of 409A compliance. Generally, this will be limited to 10-15% of all employees. Ownership or a company’s Board of Directors will usually select senior executive employees with measurable key performance tied to the company’s success as eligible.

Under what circumstances does a LTIP make sense?

An LTIP typically makes sense when a company has very clear and measurable financial objectives that they are trying to achieve. Examples such as net interest margin, ROAA/ROAE, net income, or efficiency ratio are commonly used.

Why do you believe an LTIP to be an effective retention strategy?

Proper vesting is the key to an effective retention strategy.

What is a typical LTIP vesting schedule?

A typical LTIP vesting schedule is usually cliff vesting between 3-5 years. Additionally, a company can allow the executives to continue to defer vested amounts into a deferred compensation plan provide that the proper 409A elections are made.

What is to prevent a company from changing goals, vesting or bonus payments after a key person agrees to participate in the plan?

The ability to adjust goals based on a changing business environment and strategies is one of the prime benefits of an LTIP program. However, goals set for the particular period will still remain in place as will vesting and payout dates.

Is it more important to emphasize performance or retention in an LTIP?

This is a great question for a company to ask themselves when considering an LTIP. The answer will vary at different organizations and can help to determine if an LTIP is the best plan choice to achieve these goals. If more emphasis should be on retention rather than performance, a NQDC or other plan may make more sense.

Is an LTIP part of a competitive salary?

Yes, an LTIP can be offered as part of a robust compensation package which allows businesses to compete with their peers. LTIPs can be particularly helpful for private companies trying to compete with public company counterparts that may have stock options and more long term resources as hand.

How is an LTIP taxed?

An LTIP is a form of deferred compensation and therefore must follow the distribution rules of 409A. The employer must establish when a contribution is made to an LTIP, when it will be paid in the future to the participants and how it will be paid i.e., lump sum or installments. All distributions are taxed when they are received by the participant.