On-Demand: In Your Corner--Consolidated Appropriations Act & CARES Act
February 16, 2021
Our panelists discussed the recently enacted Consolidated Appropriations Act, 2021 as well as the current implications of the CARES Act, and their impact on employee benefit plans. Additionally, they covered the effect of the COVID-19 pandemic on compensation decisions.
Robert Reilly:As Lexi said, you can submit your questions via the chat. We're going to save questions for the end if there's time since we only have an hour today, I'm not sure we'll have time to answer all the questions on the webcast. But if not, Mary and I will be receiving all the questions and someone from the Pension Services Group or from Compensation Resources will reach out to you and answer any questions or have any discussions that you'd like.
Also, for those of you who signed up for the networking session afterwards we'll address some of the questions there. So if there's some additional questions, feel free to send them and we can continue the discussion there as well.
This is the first in a series of Employee Benefit Plan webcasts that the EisnerAmper Pension Services Group is putting out. We geared this to focus on important topics impacting the employee benefits. So, on March 9th, we're going to be talking about benefit plans cybersecurity and risks surrounding remote employees. On March 30th we're going to be talking about common missteps befalling benefit plans. And on April 20th, we're going to be talking about SECURE Act and SAS136. So if you haven't already done so I would recommend registering for those sessions as well. You're on this webinar, you should have received a link to register for any and all four of these but if you didn't, feel free to just email me and I'll forward you the registration link.
I'm going to be talking about the Consolidated and the CARES Act. These are two acts that provided relief during the COVID-19 pandemic. I'm really going to focus on implications to employee benefit plans. The Consolidated Appropriations Act of 2021 is a new act that was recently passed. CARES Act, many of you are already familiar with. So my focus is really going to be on implications in 2021 and beyond.
The Consolidated Appropriations Act 2021 is a$2.3 trillion spending bill. It combined 900 billion in stimulus relief for the COVID-19 pandemic with $1.4 trillion omnibus spending bill for the 2021 federal fiscal year. It actually combined appropriations bill into one omnibus spending bill. It's one of the largest spending measures ever enacted by Congress. It's surpassed the $2.2 trillion CARES Act, which was enacted in March of 2020.
Just a fun fact about the Consolidated Appropriations Act, according to the senate historical office, this legislation, the Consolidated Appropriations Act is the longest bill ever passed by Congress, 5,593 pages. It was passed by both houses of Congress on December 21 and it was signed into law by the President on December 27 of 2020.
I'm going to discuss some of the key provisions relating to the act that impact retirement plans. Really there's four main ones I want to talk about is partial plan termination relief, limited retirement plan disaster relief, the disaster relief is not COVID related, but it's included in the act and it's important nonetheless. There's the act provided relief for money purchase plan Coronavirus related distributions. And there are a few other items that might only impact of certain specific types of plans. I'll go over them briefly just so you're aware of them, but I don't suspect they're going to impact many people on this call.
Plan termination relief. Before I talk about the partial plan termination relief that's granted under the act. I just want to go through briefly what a partial plan termination is and why this relief is important. So the only guidance that's in the Internal Revenue Code or in any accompanying regulations, it states that it depends on the facts and circumstances of each case to determine whether or not a partial plan termination occurs. So this obviously provides very little practical guidance. However, the courts and the IRS have largely considered the turnover rate as the key indicator of a partial plan termination when doing an analysis termination.
Generally a turnover rate of at least 20%, an employer initiated severance of participants creates a presumption that a partial plan termination has occurred. And it's generally 20% turnover in a applicable period. An employer initiated severance typically involved severance for reasons other than death, disability or retirement. The applicable period is generally the plan year, point to note it could be longer if there's a series of related severances.
This is an important point that needs to be considered, It's generally the plan year but not always. The 20% turnover rate only really creates a presumption that a partial plan termination has occurred. The presumption can be rebutted if after considering all the facts and circumstances of the situation, the turnover is considered a routine part of the employers business.
So again, it's a facts and circumstances based calculation. And that's why we recommend that plans consult with ERISA council when determining if there's a partial plan termination. The calculation really can be a little more complex than many plans realize, it's not so straightforward 20% necessarily.
What happens if your plan experiences a partial termination? Well, a partial plan termination would trigger 100% vesting for all affected participants. So any unvested participants that are impacted by the severance would have to be 100% vested. Contributions for those affected participants would not be able to be forfeited and used by the company to offset any future contribution. So depending on the makeup of your plan and how long people have been there, this could cost the plan sponsor some real money. So it could really have an impact, the financial impact outside of just the impact of the plan.
The reason that this was addressed in the Consolidated Appropriations Act and the reason I'm talking about it is because there has been an increase in partial plan terminations during COVID-19 for pretty obvious reasons, right? The IRS put out a Q&A about COVID related issues, for purposes of determining whether a partial termination occurred. And the IRS basically said in this Q&A that employees that were terminated due to the pandemic, the COVID-19 pandemic and hired by the end of 2020 would generally not be treated as having employer initiated severance. So for those wouldn't be counted in the partial plan termination analysis.
This position that they put on this Q&A is really consistent with their general rule. Again, everything here is a general rule that participating employees generally are not treated as having an employer initiated severance of employment when calculating the turnover rate if they are rehired before the end of the period.
And again, I just want to stress one more time, the calculation can be more involved and based on the facts and circumstances. Again, if your plan in a situation of a potential partial termination, get your ERISA council involved. But now, here's the good news. And actually I think that the partial plan termination relief is probably one of, in my opinion, one of the more important retirement plan provisions in the Consolidated Appropriations Act.
It sounds complicated, but I'll boil it down for you. So essentially, a plan won't be treated as having experienced a partial plan termination during any plan year, which includes the period beginning on March 13th, 2020 and ending March 31, 2021, if the number of active participants covered by the plan on March 31, 2021 is at least 80% of the number of active participants covered by the plan March 13, 2020.
So, to say that more simply effectively this provision of the act allows employers to rehire laid off workers by March 31, 2021 and avoid a partial plan termination. So I think there's a lot of companies struggling with if and when to bring back people that were laid off. And I do think that the PPP program certainly help in this regard, help companies keep more people on, and a lot of people were laid off. So I think if your company is considering bringing back laid –off workers, it's well worthwhile to take a look at and see whether or not that impacts whether you plan did or didn't have a partial plan termination. I do think, again, a lot of companies are going to benefit from this part of the relief package.
The act also provides for a number of non-COVID qualified disaster relief provisions. And they're similar in nature to the CARES Act retirement plan relief provisions, as well as disaster relief that was granted prior to this bill. And a qualified disaster under the act is any major disaster that's declared by the president under the Stafford Act during the period January 1, 2020 and ending February 25th, 2021.
It excludes areas where the only declared major disaster was by reason of the COVID-19 pandemic. So for instance, the California wildfires or Hurricane Isaias would be covered under these disaster relief provisions. Further, FEMA's website put together a list of all major disaster declarations. So I put a link to that on here. If you're curious what disaster declarations were declared that would qualify for this limited retirement plan disaster relief, you can just click on that website.
It should be noted provisions are optional, so plans don't need to adopt any of these. But if they do adopt, a plan must be amended no later than the last of the first plan year beginning on or after January 1, 2022. So essentially, December 31st, 2022 for calendar year plan.
Okay, so what was the relief granted? It granted qualified disaster distribution. Generally, participants can take these qualified disaster distributions up to $100,000 in the aggregate, and that would be reduced by any disaster distributions in previous years. But again, it's $100,000 in the aggregate. Early withdrawal penalty for distributions for employees that were under 59 and a half is waived. And the employee can avoid tax on the distribution if it's repaid to the plan within three years. So you're going to see a lot of these are very similar to the relief that was granted under the CARES Act.
Employees can take disaster distribution on or after the first day of the qualified disaster, up to June 25th, 2021. And to qualify, during the incident period, their principal place of abode needs to be in that disaster area and they have to have suffered an economic loss due to this disaster.
And again, these provisions are optional. Hardship distributions, it allowed for the ability to repay them for principal residence. A participant who receives a hardship distribution to purchase or construct a principal resident within a period that begins 180 days before the end of the disaster and ends 30 days after the disaster, can repay the distribution to the plan at any time during the period beginning on the first day of the disaster, ending 180 days of the act, which is June 25th, 2020. So they there's an ability to repay those distributions that were used for principal resident and avoid the tax.
And the last disaster recovery provision that was granted under the CARES Act was loan relief. So again, to qualify for loan relief, the individual need to have a principal residence in the qualified disaster area. Need to have sustained an economic loss from the disaster. The loan max is $100,000. For any loan that was taken during the 180 day period, beginning on the date of the act and ending June 25th, 2021. It's effective for both new loans and existing loan. So loan repayments that are due on the first day of the qualified disaster incident ending 180 days after can be delayed for up to a year, but subsequent loan repayments would be adjusted to reflect the delay.
So other than the date periods, these are very similar to the relief that was provided under the CARES Act. But again, these are for non-COVID related disasters and it has to be a qualified disaster that was listed on that website, and plans need to adopt this, elect to adopt. So there's some significant relief here as well.
Okay, money purchase plan Coronavirus related distribution. Well, under the CARES Act, money purchase participants were not eligible for Coronavirus related distributions. Just a reminder under the CARES Act, you could take distributions in 2020. If they were eligible distributions, they could be repaid within three years, and participants could pay them back. And those paybacks would be treated as actually rollovers into the participant account.
But this wasn't initially granted to money purchase plans. What the act did was retroactively applied the Coronavirus related distribution rules to money purchase plan distribution. Why they do this? Obviously, this was signed at the end of 2020. And they only gave to December 31, 2020. The release came so late in the year, it was really very unlikely that a money purchase plan was going to be able to implement this, and the purpose of it was it provided relief for money purchase plans that mistakenly granted COVID related distributions during planning. So there were a number of money purchase plans I think that didn't realize that they were not eligible, technically under the act. And this remedied that so there's no operational defects in the plan. It's cured under this provision of the Consolidated Appropriations Act. So that was I think, beneficial.
Robert Reilly:So more than half of the people on here have plans that require audits and 23% don't, which I assume are smaller plans. Okay, fantastic. Thanks Lexi. I think I just had one other slide here. There's not really much to discuss on this other relief that was provided under the Consolidated Appropriations Act. It's not likely going to impact large number of plans. The act also provided for a multi-employer plan minimum age distributions during working retirement.
Essentially, certain multiemployer plans that participate in the buildings construction industry can pay some benefits earlier. And then it's granted for transfers of excess pension assets to retiree health or life account. So currently, certain retiree health and life insurance costs can be transferred from a DB plan to a retiree health and life insurance account within the plan. And in order to do that they had to elect to do it and do it over 10 years. So the act says you can essentially make a one time election to stop doing that.
I don't think that there's much that's going to impact many people on this call. But if it does, great. We've got some additional relief. So I hope the audio problems didn't hinder my presentation on the Consolidated Appropriations Act too much, because there were some important stuff and important relief in there. But if it did, and anyone wants any clarity, again, feel free to put something in the comments and we will get back to you on that.
But I think that sums up what retirement plans really need to know about the Consolidated Appropriations Act. Obviously, it's a huge act. And there is some targeted relief for benefit plans. So I think everything from a retirement plan standpoint that came out of there was pretty good. So we'll see how that plays out.
I want to switch gears a little bit and talk about some of the key things that plans should consider relating to the CARES Act provisions if they have implemented because again, it was optional. And also some of these are just really related to the impact of a pandemic on plan operations.
Just briefly the Coronavirus aid relief and Economic Security Act or the CARES Act was signed into law on March 27, 2020. Just want to quickly recap a few of the provisions for a few things that I'm going to talk about. Again, these were available to plans that elected to implement them. There was relief COVID-19 related distributions. So participants that met specific conditions were able to take COVID-19 distributions up to 100,000 without the 10% early withdrawal penalty. They could be taken any time during 2020 and repaid within three years, right? And the repayments had to be treated as tax rollovers into participants accounts.
COVID-19 related participant loan relief, participants that met certain conditions were eligible to take loans up to 100,000, which was double the previous $50,000 limit. And that was allowed for the period in March 27, 2020 to December 23rd, 2020. And participants were able to delay loan repayments during that period by up to one year. And required minimum distributions for DC plans were able to be temporarily suspended for 2020. I'll talk about this later in my presentation. But I'm thinking about it now, we're into 2021. So any RMDDs that were suspended in 2020 should have been reinstated in 2021. So you might want to just administratively, just take a quick look to make sure that you properly reinstated any RMDs that were suspended if you adopted provisions of the CARES Act relief.
There's four things I think that plans should be considering, four main things now with respect to COVID and the CARES Act. There's the retroactive amendment deadline under the CARES Act. There's untimely contribution due to COVID. Plans may have some challenges administering distributions and participant loans under the CARES Act provisions. And plans during 2020 have been dealing with new types of compensation. And I want to talk about that a little bit as well.
Okay, so this is really just a reminder not to lose sight of this. If the plan sponsor decided to implement the provisions of the CARES Act, the plan needs to be formally amended prior to December 31st, 2022, and that's required by the act. So many plans adopted these provisions and if the plan is not formally amended by the deadline, then the plan is not going to be operating in compliance with it's own plan document. And that's an operational defect of the plan. I know most people I've talked to their providers or updating for these amendments, but don't again, this is also something not to lose sight of. I know there's still time, but keep that deadline in mind.
All right, one of the main things I want to talk about with the CARES Act, not necessarily the CARES Act, I guess more just COVID related is untimely contribution. So during COVID, plan sponsors or so maybe but they really weren't challenged to deposit participant contributions in a timely manner, especially when the pandemic first hit back in March of 2020. And people were, we flipped a switch and everybody was working at home. So administratively, it was difficult. There were difficulties and I know there were a lot of plans that experienced some late contributions.
There is relief with regards to late participant contributions and loan repayments during COVID. There was a disaster relief notice, EBSA, disaster relief notice 2020-01 where the Department of Labor essentially said, I would encourage you to read it. But in a nutshell, they basically said that if you have a late remittance during COVID and it's strictly COVID related, that they're not going to take any further enforcement action. It still needs to be reported as a late contribution, but presumably what they're saying is they're not going to take any enforcement action on it.
So let's talk about what you can do. First of all, what is an untimely deferral? Well, the DOL says that employee deferrals must be remitted at the earliest date they can be segregated from general assets of the company, but in no event later than the 15th business day following the month the amounts are contributed by employees are withheld from their wages, so this includes loan payments, right?
So a lot of people get tripped up the 15th day of the following month, that's not a safe harbor. What the DOL basically says is you have to remit the earliest date you can segregate them from the general assets of the company, right? So obviously, this is subjective. And plans, you're going to need to make an assessment on their own as to whether or not a contribution is late or not.
Well, there's two main ways to correct a delinquent participant contribution. One is under the voluntary fiduciary compliant correction program, the VSCP. And the other is what the DOL calls the SCP, the Self-Correction Program.
For the Self-Correction Program, you could correct insignificant operational errors at any time. However, significant operational errors need to be substantially corrected within a reasonable time or before the end of the second plan year or after the error occurred. In any case, however you correct it, the plan needs to calculate and restore in the lost earnings to the participant. And so, there's pros and cons to using the VSCP versus the Self-Correction Program.
Using the Voluntary Fiduciary Correction Program, the VSCP protects plan sponsors from the DOL possibly taking an enforcement or audit action. And in some cases, the IRS also may relieve the plan sponsor from paying the excise tax on the missed earnings as well.
Another potential benefit of using the VFCP is that missed earnings calculations are based on the IRS rate for underpayment, it's often lower than the plan's rate of return, there may be some cost savings there. The way the VSCP works is the plan sponsor has to make the corrections first and then apply for the program, essentially showing the Department of Labor. "Here's what happened. Here's how I corrected it." And if the Department of Labor agrees that the corrections were done and approves of it, they'll issue what they call a no action letter that frees the plan sponsor from further enforcement actions. Essentially, they're never going to say, "Yeah, it looks great." But they're going to say, "We're not going to take any further action on this." And that's the best you're going to get.
The downside to the VSFCP is it can be time consuming and it can be an expensive process. So as a result, some plans choose the self-correction route, which can be quicker and cheaper, although not always cheaper. There are cases where self-correction ends up being more expensive. And that's because some plan sponsors take a more conservative approach to try to decrease the chance of an audit or further action from the DOL. And they really err on the side of safety when determining the amount of missed earnings that needs to be funded. And they wind up sometimes paying more than they would have under the VFCP.
So generally, what I've seen when plan sponsor are correcting under the Self-Correction Program, they calculate the lost earnings using the greater of the plans actual rate of return or the rate set by the IRS for underpayment. So if the plan is over performing at IRS rate, a lot of times they're paying more under the SCP. But again, that's done because the SCP doesn't provide you as much of an umbrella as the VFCP does.
And then again, under the SCP there's no chance that you're going to get any of the excise tax forfeited. Similar to what I discussed on the partial terminations, I would advise plans to get their ERISA counsel involved in any corrections of untimely deferrals. Not only do you need to correct the deferrals, but they need to be reported on your Form 5500, on Schedule H. There's a question that needs to be answered and the amount of the untimely deferral has to be entered.
And in addition, in the attachment to Form 5500, there has to be a schedule of delinquent participant contributions. They call them delinquent contributions, they're really late contributions. They need to be reported until they're corrected. And what does that mean? Well, a delinquent contribution is not corrected until lost earnings are funded. So it's not when the contribution is made, that's still not corrected. It's not corrected until you've calculated and funded lost earnings. And they're reported every year, up to and including the year they're corrected.
So, if there was an error in 2020 that was caught and corrected in 2021 by funding lost earnings, it would get reported in 2020 and 2021. And then Form 5330 will be filed to pay the excise tax, which is usually 15% of the lost earnings. And important to note that that excise tax cannot be paid by the plan, it needs to be paid by the plan sponsor, by the employer.
I'll just briefly talk about distributions. Again, just don't forget that redistribution repayments are treated as tax free rollover into the participants account. So make sure you're treating them properly. And from an accounting standpoint, they should be reported as rollover contributions not as a deduction to your distributions.
There's some interesting things with participant loans, right? So I mentioned before, participants who met certain conditions could take loans up to 100,000 and if the repayments were due between March 27th, 2020, and December 31st, 2020, they can delay those loan repayments for up to a year. So that caused some other issues for the plan. And that's really what I have here under loan re-amortization.
The IRS hasn't really explained how the provision should work. So what plans are doing is they're following previous guidance that address loan suspension granted under Katrina Relief Act of 2005. And of course, the IRS never really explained how so it should work either, but they did offer somewhat of a safe harbor, which said that immediately after the suspension period ended, the remaining loan balance plus accrued interest should be repaid in level installments within the original loan-term plus the length of the suspension. So in effect after the loan period suspension is over, the loan can be re-amortized to reflect that delay and interest needs to be accrued for the delay period.
Finally, with participant loans, monitoring defaults, I just want to say one thing about that. Because the maximum loan amount was doubled to $100,000. And while there was a one year delay, the repayment terms weren't changed on loans, other than the one year delay. So you're going to see an increase in defaults, people are going to have higher loan payments when they come back, right? And I think it's likely that a participant qualify for the loan, it's possible their financial condition has worsened. So I really expect we're going to start to see an increase in loan defaults.
And plans should really be on the lookout for this and carefully monitoring them. Loan defaults has always been a tricky issue as far as plans monitoring them. But I think now with COVID and these, especially if plans had a lot of COVID related loans, I would advise monitoring them really closely for potential defaults.
Okay, the final thing that I want to talk about is new types of compensation. During COVID, plan sponsors may have compensated employees in various new ways that are different than what they traditionally did. For example, you have clients that had paid out vacation, so they have vacation payouts, severance. Expense reimbursements that they haven't had before or other types of expense allowances, just things that they had to do during COVID but they never dealt with before.
As an auditor, this is something I worry about. Because whenever plans encounter new forms of compensation they haven't traditionally dealt with, that's when we see an increase in definition of compensation errors. And those errors can be somewhat costly to correct. So I just want to say, I would urge plans to carefully review their definition of comp. I know that these forms of compensation have likely already been paid out. So again, you're not going to be able to correct them before it happened, I would think, but the sooner you catch any errors that were potentially made, the better. You don't really want to be in October trying to figure out if you have problems with your definition of compensation or not, so the sooner you catch these errors, the better. So I would suggest really plans take a look at like, here's what they paid out, here's what the plan document definition of comp is and make sure that they're consistent.
I want to end with this because I think that's an important one and I'm just fearful that we're going to see more errors this year due to COVID. And as I'm discussing compensation, compensation hasn't really been spared the impact of the pandemic either. And that's why up next, we have Mary Rizzuti, she is the managing director of Compensation Resources. She's going to share some of the work that she's been doing to assist her clients with the challenges that have arisen over the past year. I think before Mary talks though, I believe we have a polling question.
Robert Reilly:Thanks Lexi. I guess these are about what I would expect. Adapting to new regulations is always a concern for plans, keeping up with plan ministration; I can certainly feel the plan sponsors' pain there. So these are very interesting results and I guess it's along with what I was expecting. Thank you. Mary, I'll turn it over to you.
Mary Rizzuti:Thank you Robert, and thanks for the great lead-in. Good afternoon everyone. I'm pleased to give you a little bit of a view into the work we've been doing with our clients. And certainly we're all in uncharted territory. And what we've seen is a lot of attention and concentration in certain areas, and I thought it would be helpful to give you a view into some of the creative solutions that we're discussing and considering.
Although this is compensation focused, you'll see an overlay in organizational development, operational efficiencies and risk mitigation. We'll look at base pay administration, the at risk portion of compensation, which of course caused quite a bit of challenges and top of the list is sales compensation, and then the importance of communication.
So if we start at the 2020 response, the first response was hiring freezes. Everybody put on the brakes and really took a moment to take a look at what was ahead of us. And we all knew, we couldn't imagine what was ahead of us. There was a reduction in staff, there was a reduction in hours and there was a reduction in base pay. Some organizations chose one, other organizations did all three.
Then there was consideration of bonuses, what exactly would happen with bonuses if the targets couldn't be met, and were the targets even appropriate? During open enrollment, there were modifications to benefits offering as well. And then the sales compensation challenges became more apparent as we move through 2020. What was different though in the manufacturing, distribution and warehousing industries, they were facing a different challenge. So they were looking really to incentivize people to come to work.
The immediate response was fear. And nobody really wanted to be on the warehousing floor. In addition, the additional remunerations that people were receiving to not work sometimes were outweighing the actual salaries that individuals were earning. So that posed another challenge and a way in which we had to start to look at compensation a little creatively. Now we move to the 2021 strategy and that's exactly what it's become, it's become a strategy.
So we saw conservative salary increases. And yes, I would say on average, most organizations provided some kinds of increase. There is this appetite to retain talent. So even though we're in a crisis, we still need to take care of our people and make sure we protect our human capital. There's attention on a more granular approach to performance metrics. So if we're going to be missing on our financial targets, what else can we consider to continue to engage and reward and recognize our employees?
We've looked at bifurcated performance periods. So where we may have seen a 12 month performance period for an annual plan, we've now bifurcated some of those and did a phase one, first six months and a phase two, second six months because of the challenge of forecasting performance and targets. We've seen an increase in equity and phantom equity plans in an effort to send the message, "Stay with us, stick with us and you'll be rewarded in the future. We may be having a hard time right now but in the future, we believe we're going to turn this around."
And then the continued sales comp challenges. So assessing the plans, reworking the plans, trying to get some flexibility around the metrics and the desire to keep people whole. And so we've seen places where we're looking at what was earned in the past and almost working backwards from that number in order to not harm the sales force with respect to remuneration. The short-term fix really is to retain the talent that they need to move their organizations forward.
So what was learned? Really, what we saw was a right sizing of organizations, but also the wake up of we may not have all that we need in place to run an efficient and effective organization. There were certain shortcomings that became pretty apparent. So maybe there was a lack of formalization of programs around base pay and variable pay. There was a need to clarify incentive metrics, a deliberate communication policy around many instances. So there were many employees that were asking questions that employers didn't have the answers to.
Severance policies, what is your severance policy? Do you have any kind of tiered approach? What about flexibility and hours? What about overtime? Are your FLSA examination still current and applicable? And then we jump to base pay equity analyses. So as organizations were right sizing and we were looking at their organizations, some inequities became apparent and we were able to provide some tools, best practices and methodologies, not only to correct but to identify.
And then equally important was the lack of succession planning and talent development. So if I have an employee that is out of the office for three to four weeks due to an illness, do I have a safety net? Do I have a plan in place to transfer talent, transfer duties and responsibilities? What talent do I have within my organization that I can leverage? So that comes to protecting your assets. And regardless of your industry, your employees are your differentiators. It’s about their commitment, their engagement, their trust and without having focused programs in place with a deliberate communication policy, we don't necessarily always have that protection in place.
Retention is consistently at the top of management's concerns in almost every survey that we see. Retention programs are becoming very popular; it's not only about rewarding individuals. We have some organizations that are putting programs in place that actually encourage employees to apply for jobs, maybe in other departments. But as long as they can keep their internal talent within the confines of their organization, they consider is a positive outcome. Employers are becoming less bothered by losing talent within certain departments and are happy to make an internal hire to another department.
Lost talent is costly: there is recruiting time and cost, the cost of training to close the learning curve and then there's the cost of a poor hire. The US Department of Labor estimates 30% of an employee's first year earnings for the cost of a new hire or a poor hire. So we start to use compensation as a strategy. And the strategy begins with your compensation philosophy.
The need to be able to articulate that strategy and the methodology behind what the strategy is and how you arrived at it a particular strategy, is very important in developing confidence among your employees. Your talent acquisition and retention strategies will change. There's a wider net that is being cast now for talent because of the remote environment that we're now operating in. We're looking at more work life balance and flexibility within our employee populations.
Switching to base pay and variable pay strategies: there is now a focus and recalibration of base pay and variable pay strategies. On the base pay side, we're looking at more formalized programs in the way of grades and ranges. On the variable side, setting meaningful metrics and connecting those metrics to core duties and responsibilities of positions, as well as impact, are critical to successful programs. Many organizations have a strategic plan. The questions: what is the plan, who's driving the plan, who are your high impact employees who can make a difference in moving the organization to achieving that strategic plan; That is really what we're looking at when we're defining metrics. It's not only about the job description, it's not only about core duties and responsibilities, it's now more than ever important to move the organization and find a way to leverage your talent to do that.
On the sales compensation side, this has been a very interesting engagement for us. So it's almost that coat that you continue to wear, that you love wearing. And you don't really recognize that it may be time to change the coat. But it's worked for you up until this point, until somebody says to you, "Oh, you're still using that same coat?" It's the same with the sales compensation.
When we start to examine plans, it starts to become apparent that maybe some of the plans have turned into annuity plans. Maybe there is little effort required from the sales force in order to receive commission. Is the commission program driving the behavior and the products and the services that now comprise what your new organization is focused on? And let's face it, most organizations are in an entirely different place today than they were a year and a half ago.
Let's look at a VP of Sales. Should that VP be on a commission program? Or should they now be changed to an incentive program? Or should it be a hybrid plan? How are you using your customer service people? Are they appropriately focusing their time? We have found many salespeople spending a good deal of time e in customer service roles where there needs to be some release of that responsibility so that they can become hunters more than farmers. Again, it's about your strategy and where you want to move your organization to.
On the base pay side, benchmark studies are highly effective in testing what your external competitiveness is. You look at your industry; look at the size of your organization and your location, although location may become little less important now that we are now in a remote environment. But we also want to look at internal equity. And you'll see on the next slide how we do that.
We want to balance your external competitiveness and your internal equity. We do that through salary grades and ranges. We also provide a position matrix. A matrix allows you to look at your organization from a functional area perspective. We take the incumbent out of the position and simply look at the positions and how positions compare to each other from a functional area perspective.
The documentation is through a salary administration manual. What are your policies and procedures around promotions, lateral transfers, downward adjustments? And then the communication piece, and we've had a lot of conversations with clients on this. We use the word transparency, and transparency can mean many things. Transparency and compensation doesn't necessarily mean that salary grades and ranges need to be published throughout the entire organization. It could mean that you want to just communicate that you've done a market study, that you have tested the competitiveness of your sales, of your employee population, that you've looked at internal equity and that you're confident from a base salary perspective, from an empirical data perspective, that your compensation policies and procedures are sound.
So this is an example of a salary structure and a position and range analysis. You'll see on the right side, that's your salary structure, and that's built around market data. Structures should be built uniquely to every organization;, there is no one size that fits all. And you see, we have bands, we have a low middle and high band. So I chose a Senior Associates Distribution Center person. We have four incumbents in the same role. We have an annual salary range from 35K, all the way up to 49K.
Now, it doesn't necessarily pull a trigger to say there are inequities. What it does is it encourages us to look at the incumbents. So the first place we look is at the incumbent who is below minimum. Is there a performance issue? Is there a learning curve issue? Is there just something that slipped through the cracks during hiring or merit increases? On your low band individuals, why do they place in the low band? Is it again that they were hired at a lower rate? Or is it that the person who is in the middle band was hired at a higher rate.
So while this starts the conversation, it doesn't necessarily set an alarm that there's an issue, but at least we have a way in which to measure and evaluate the staff and the related compensation. You have a bring to minimum opportunity to evaluate what it would cost across the organization to bring those who are below the minimum up to the minimum.
The position matrix that I referenced earlier is shown here. This allows us to look at the organization from an operational standpoint. So if I look at operations, finance and marketing, I have a level of chiefs, I don't have VPs. And in two functional areas, I have senior directors in grade 48. I want to start to look at those areas and decide is in fact the senior director in IT placed at a higher grade than a senior director of finance. What drives that decision are several things.
One is the market data. But the other piece of it is how is the organization using this position? What is the value that the organization is placing on this position from an internal perspective? And again, there is no one right answer for one organization across the board. But this gives you the time and space to have validity behind what you're doing, have a process in place for evaluating positions and being prepared to answer questions when asked.
When we look at variable comp in 2021. It's about budget and goal modifications, reward and recognition programs. So we're seeing non-monetary reward and recognition programs being put in place to conserve cash. On the short-term incentive piece, we're looking also at monthly quarterly payments as opposed to an annual bonus program in order to separate the performance periods and be able to manage both forecasting on a spend and forecasting on metrics.
On the long-term incentives, we're seeing usage here not only at the senior executive level, but throughout organizations, we're seeing cash based plans, performance shares, performance units. We're seeing a little bit longer vesting periods, four to five years, but I've actually seen some that are eight years. And that really looks at a strong retention device.
Now we look at this at the higher levels within an organization not typically at the lower levels. But again, we're seeing a lot of creative ways in which organizations are making strides in retaining their people.
With respect to the trends around sales compensation, surprisingly, we've seen movement towards guaranteed payments for top producers for this year. So again, while people are pivoting, trying to rebalance their performance in order to keep their top producers, they're looking at guaranteed payments.
We're also looking at eliminating below average producers. So when we saw reduction in force in the beginning, many organizations communicated to us that it was, yes, COVID-related. But it was an opportunity also to truly evaluate who was within the confines of the building? What were they doing? What skills do they have? And did they really impact the bottom line to the extent that organizations now needed that impact?
We're also seeing inclusion of behavioral factors and payouts of salespeople. So we know that sales people sometimes are hard to manage. They're built that way because they're hunters and they're producers. But there's also this appetite to rein in their performance and make sure that they continue to connect to the values and core mission of the organization without being completely autonomous and disconnected from the organization.
We're identifying the drivers. Now this seems like something that would be a no brainer in the sales comp realm. But we've seen plans again, when we dust them off, and we start to assess them that were driven only by revenue. And when we start to ask questions about gross profit, about annuity plans, about new products and how we're going to drive those behaviors, we start to consider updating some components of the plans that are in place. So here we have a gross profit margin model. This was a revenue model but what the company did was change it to a gross profit model. And you'll see that a gross profit below 3% gets no compensation. So 3% was the threshold for a gross profit. And you'll see that it's tiered - as you increase your gross profit margin, you increase your commission.
And it's also tiered by position, so this is about impact. Who's doing what? Who's contributing what to the sale? And how do we pay them? Paying on gross profit gives you more control over your costs. Some organizations had been paying on revenue and did not realize that they were giving away too much of their gross profit without really understanding who was getting what and why.
This is a revenue gross profit matrix. So this looks at both revenue production and gross profit. And you'll see it's a matrix model that increases with revenue and gross profit in tandem. The plan is capped and we believe that most plans should be capped. But again, it's unique to each organization strategy and sales organization composition.
Lastly, I want to talk about communication. Communication is key, and while we talk about communication, we want to commit to doing things differently, maybe commit to a more formalized manner in which we approach compensation, because the goal really is sustained motivation and engagement. It's high performance in a challenging environment. Most importantly, it's retention of the right talent. But leveraging all talent take a skills analysis - see who you have in your seats and are you using them to the best of their ability and are they being remunerated competitively and internally equitably? Strive to get the most out of your compensation spend.
There is a strong energy around understanding comp as a business strategy now beyond an HR strategy. I appreciate the time that I've had with you today. Hopefully, everybody had a little bit of a takeaway in these slides. And if anybody has specific questions for me, I look forward to seeing you in the networking room.
Robert Reilly:Thanks Mary. This is Rob. That was a great presentation, very informative.
Mary Rizzuti:Thank you.