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As you move up in your career, you’ll likely encounter new, curious, and exciting things at every stage – new responsibilities, a bigger office, increasing pay, and even unfamiliar forms of compensation. One such development, a long-term incentive plan, is a common way to reward employees for growing alongside their organizations.
Settling into a new role and adapting to its responsibilities often leaves little room to digest the workings of a new pay structure. If you’re going through one of these transitions, you likely have plenty on your plate already, so let’s keep it simple. Here’s a quick rundown with everything you need to know about long-term incentive plans and nothing you don’t.
What Is a Long-Term Incentive Plan?
A long-term incentive plan, or LTIP, is a way for a company to compensate employees for delivering on long-term business objectives. Unlike standard base salary and annual bonuses, an LTIP often has conditions for the employee to meet particular time-bound criteria to earn the full benefit.
By combining an LTIP with more conventional forms of pay, a company can incentivize employees to focus on big-picture outcomes and the overall growth of the business. Jorey Bernstein of Bernstein Investment Consultants elaborates:
“Long-Term Incentive Plans (LTIPs) are an integral part of a comprehensive compensation strategy, particularly for higher-level executives and key employees. They’re designed to align the interests of employees with the long-term goals of the company, as well as to attract, retain, and motivate top talent. As the name suggests, LTIPs are not immediate cash rewards; rather, they offer deferred compensation based on the achievement of specific performance goals over a defined period.”
These plans can also boost employee retention in highly competitive industries. Reaping the full benefits of an LTIP can motivate employees to stick around rather than move to a new job and forfeit that compensation.
Long-term incentive plans are often part of the overall compensation packages of executives and other high-ranking employees but aren’t necessarily exclusive to this group. Many employers in highly competitive industries now offer LTIPs at lower levels of the corporate ladder to help attract and retain top talent.
How Does a Long-Term Incentive Plan Work?
“Long-term incentive plan” is a broad term that encapsulates many different types of incentives. It is more of a category than a specific instrument. An LTIP can work in many ways, depending on the type of company, its goals, and which sort of incentive it offers.
Often, an LTIP will go hand-in-hand with an offer for a new job, promotion, or raise. The employer can also offer one at other times, such as annually or at the start of a new company initiative.
After agreeing to the plan, the employee will have a clear set of objectives to complete to earn the pre-defined incentive.
In many cases, this objective is a vesting schedule that doles out company stock or options to the beneficiary based on their years of service with the company. Other times, the benchmarks are based on individual or company goals and follow key performance metrics. In either case, the plan motivates the employee to strive for long-term company growth rather than focus too narrowly on their own work.
LTIPs can significantly benefit both sides. Employees can earn significant remuneration with potentially more upside than their base salary, which reflects their productivity level. Employers can motivate their team members to drive business outcomes and withhold resources when those team members come up short or leave prematurely.
Types of Long-Term Incentive Plans
Since LTIPs are a broad category of payment structures, there are many ways to implement one. Each company can have its own forms of LTIPs, likely several in many cases, but here are a few of the most common and recognizable.
401(k)s
One of the most common forms of long-term incentive plans is the 401(k). Access to an employer-sponsored retirement plan is an excellent employment benefit in any case, and it is an exceptionally reliable way for companies to encourage long-term service from their staff.
Having access to an account where a person can reliably save toward retirement is an effective way to keep employees happy and focused on the long-term health and stability of the business. Many 401(k) plans have vesting schedules and employer matches, both of which incentivize sticking with the organization and discourage job-hopping.
Restricted Stock Grants
Many companies offer stock benefits such as restricted stock units, or RSUs, as a form of long-term incentive plan. These plans are especially popular among employers of tech professionals. After receiving an often-sizable grant of restricted shares in the company, the employee must complete a vesting period, typically a few years, to fully vest in those shares.
Restricted shares will continue to appreciate after the grant date as long as the company’s stock price grows, but they won’t become available until after they vest. In other words, jumping ship early means not getting the full benefit of your shares.
Stock Options
Similarly to stock grants, stock options allow employees to buy shares of company stock at a discount. Offering these benefits on a vesting schedule encourages employees to stick with the company for a longer term and drive business growth during that time.
Empowering an employee to become an owner of company stock encourages them to think like a business owner. Owners are likelier to consider the big picture and push through day-to-day challenges to reach more significant long-term rewards.
Long-Term Incentive Plan Example
Let’s illustrate how an LTIP can work with an example.
Ruth works in management at a large company. After earning a promotion to a new position, in addition to the salary increase and other benefits of the new role, she receives an LTIP. In this case, it is a grant of 200 restricted shares of company stock (RSUs) with a 5-year gradual vesting period.
The company grants all 200 of these shares and sets them aside on the first day of Ruth’s new job. They are hers in name, but she does not have access to them yet.
One year later, 20% of Ruth’s grant will have vested (40 shares). She is free to continue holding these 40 shares, sell them, or do anything else she likes with them. The following year, another 20% will vest, and so on, until the five-year mark, at which point Ruth will be 100% vested.
This plan incentivizes Ruth to support company goals in at least two ways. First, the vesting schedule gives her a reason to stay working for the company. If she leaves within those first five years, any unvested shares of her grant go back to the company.
Additionally, it encourages her to think like an owner. From the first day the company grants those shares, even before they vest, Ruth’s financial growth is tied to the company’s. If the stock price grows, so will her eventual reward. She now has plenty of reasons, apart from her salary and seeking her next promotion, to help the business achieve its goals.
Is a Long-Term Incentive Plan a Bonus?
You can think of an LTIP as a bonus, though perhaps not in the strictest sense. A cash bonus from your employer during the holidays or at the end of the fiscal year is not usually considered a long-term incentive plan.
However, in the broad, everyday sense of compensation above and beyond your base pay, an LTIP can easily fall under the umbrella of bonuses. Most LTIPs result in either a cash-based form of payment or something that can be converted to cash, like stock payouts. Most holders of an LTIP consider it part of their overall compensation plan, making it loosely fit under the umbrella of bonuses.
What is the Vesting Period for a Long-Term Incentive Plan?
By their nature, it is common for LTIP benefits to include a vesting schedule. Vesting is usually a core component of what holds these plans to a long term. However, there are too many variables at play to give a decisive answer on the vesting period for all LTIPs.
As with other terms and functions of LTIPs, vesting schedules will depend on the organization and the type of LTIP in question.
In most cases, plans will vest over a period somewhere between one and five years. This vesting may occur gradually, as in the example above, partially transferring complete control to the employee over the course of the vesting period. In other cases, plans use cliff vesting, in which the plan immediately becomes 100% vested after a set milestone such as three years.
Long-Term Business Goals, Long-Term Growth
Advancing in your career comes with many rewards. Some are material rewards like higher pay or better benefits. Others are less tangible, like more extensive responsibilities or the sense of pride and status that come with rising into a new role. Long-term incentive plans are a little bit of both – an opportunity for financial reward and a strong sense of connection to the results of your work.
LTIPs can be as diverse as the many organizations that offer them, each with its own unique terms and mechanics. But in all cases, these plans provide a solid motivator to continue growing and rising to new challenges, and reaping significant rewards for getting there.
About the Author
Sam is the creator of the personal development blog Smarter and Harder. His mission is to start exciting new conversations that empower people to improve their work, lives, and money, and have fun doing it. In all things, he strives to lead with positivity, understanding, and more than a bit of enthusiasm.
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To make Wealthtender free for readers, we earn money from advertisers, including financial professionals and firms that pay to be featured. This creates a conflict of interest when we favor their promotion over others. Read our editorial policy and terms of service to learn more. Wealthtender is not a client of these financial services providers.
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