Long-term incentive plans reward employees for outstanding work performance or length of service, with bonuses paid in cash, stock, or profit shares. They discourage unethical behavior and often have lower tax rates than short-term plans. These plans are reserved for high-level employees and can require waiting at least a year or five years before receiving full bonuses.
A long-term incentive plan has a company provide employees with a bonus as a reward for outstanding work performance or provide bonuses to employees based on length of service. Under a long-term plan, an employee can often start earning bonuses based on short-term performance, but doesn’t receive those earnings until some point in the future. Most long-term service plans require employees to wait at least a year before receiving bonuses, and many plans require employees to wait at least five years before receiving full bonuses.
Using a long-term incentive plan discourages employees from acting unethically in pursuit of short-term financial gain. People working in sales and finance need to produce consistent results over several years and this prevents people from skewing sales results in the early years, as such actions would be caught long before incentives are paid out. Some companies offer both a short-term and a long-term incentive plan, and the latter builds on the results of the former, although the rewards are much more substantial in the long-term plan.
Under the terms of a long-term incentive plan, employees usually receive their bonuses in the form of cash, company stock or profit shares. Cash bonuses are paid along with employees’ regular salary on the plan’s end date. Stock incentives require the company to purchase its stock on behalf of the employee or to provide the employee with an opportunity to purchase stock at a below-market rate. Stock option plans are based on the assumption that the value of the company’s stock will increase over time rather than decrease. Profit shares result in the employee being rewarded a fixed percentage of the company’s profits during the time period that the long-term incentive plan is in effect.
Employees who participate in long-term incentive plans often pay lower taxes on bonuses paid through those plans than on bonuses paid on short-term plans. This is because, in many countries, the tax rate on long-term capital gains is lower than the tax rate at which short-term incentives are taxed. Long-term plans are often reserved for high-level employees and are designed to ensure that these key employees remain loyal to the company. In situations where the company’s results deteriorate over time, company employees can end up with minimal bonuses at the end of a long-term incentive plan.
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