Nonprofit Variable Pay

SUMMARY

Like for-profits, nonprofits are increasingly turning to variable pay to attract, motivate, engage and retain employees. However, nonprofits must heed the strict requirements for reasonable pay or face intermediate sanctions established by the 1996 Taxpayer Bill of Rights.

Plan Design

A successful variable pay program should be competitive within the defined labor market and compatible with the culture, strategy, and requirements of the organization. A well-designed plan can influence valence, performance-reward, and performance effort connections. A plan can be even more effective when both employee and organizational requirements are met.

In today’s environment, organizations look for ways to increase revenue while controlling operating expenses and ensuring customer satisfaction. Variable pay can complement these goals and motivate participants to achieve important organizational objectives.

An organization will need to determine the type of plan used:

• Short-Term Incentive – up to 1 year performance period
• Long-Term Incentives – 2- to 5-year performance period
• Bonuses – one-time awards
• Recognition Awards – one-time awards

Short-term incentives are the most widely used by nonprofit organizations and include the following:

• Annual Incentive Plan (most common plan in use by nonprofit organizations)
• Discretionary
• Team-Department/Unit/Organization
• Profit Sharing Plan

The annual incentive plan will typically support an organization’s strategy to attain important tactical objectives which complement the longer-term goals of the organization.

Careful consideration must be made for the level of the plan (individual, group, or organization-wide) and the performance standards selected. Performance measures must be simple and objective, so employees understand them and find them to be fair. It is a good idea to get employee approval of standards used so they feel more involved and less threatened by the new pay plan.

Executive Benefits

Nonprofits may use short- and long-term incentive plans (STIP and LTIP) such as annual bonuses and nonqualified deferred compensation plans (NQDPs) to reward and retain executive staff. For a NQDP to avoid current taxation for employees, it must follow the rules of constructive receipt, economic benefit, and risk of forfeiture.

Variable compensation, top hat plans, and perquisites are methods used to reward executive performance beyond a competitive base salary.

Plan Maintenance

To maintain a successful variable pay plan, it should be reviewed and updated regularly. For example, if the performance period is annual, progress towards financial and operational objectives should be reviewed at least quarterly, and the plan should be updated or redesigned annually. The plan should include a formal plan document and be well communicated to plan participants and management. Progress towards objectives should be communicated as well.

Plan participants must “own” their participation in the plan and their ability to influence the desired results. The financial and operational objectives must be attainable. A failure of variable compensation plans is setting the objectives too high or too low. Employee perception is important to manage. Participants should be able to influence the results to attain the plan payouts.