Long-term incentive plans: A comprehensive guide for HR

Long-term incentive plans (LTIPs) are an essential part of modern compensation strategies, offering significant benefits for both organizations and employees. These plans not only help retain top talent but also align employee goals with long-term organizational success. By focusing on rewarding sustained performance, LTIPs play a crucial role in fostering employee loyalty and driving business outcomes.

What is a long-term incentive plan (LTIP)?

A long-term incentive plan (LTIP) is an incentive compensation strategy designed to reward employees for achieving predefined objectives over an extended period, typically three to five years or more. LTIPs aim to align employee efforts with the company’s strategic goals, fostering sustained contributions that drive organizational growth and success.

Unlike short-term incentive plans (STIPs), which focus on immediate or annual performance outcomes, LTIPs prioritize long-term value creation. While STIPs often involve cash bonuses based on short-term metrics like quarterly sales or annual profits, LTIPs reward employees for achieving goals tied to the company’s future, such as stock price growth, market expansion, or innovation milestones.

By bridging individual performance with the organization's long-term objectives, LTIPs not only incentivize employees to stay committed but also enhance retention by offering rewards that build over time. These compensation plans are particularly effective for fostering a sense of ownership among key employees and executives.

Common types of long-term incentive plans

Organizations use various types of long-term incentives (LTIs) to attract, retain, and motivate employees. Each type of LTI offers distinct benefits and limitations, making them suitable for different business needs and employee roles. Below are a few common types of LTI awards: 

Restricted stock units (RSUs)

Restricted stock units (RSUs) are shares of company stock granted to employees that vest over time or upon meeting specific performance milestones. Employees receive the shares once they meet the vesting requirements.

• Benefits: RSUs provide a straightforward way to reward employees while aligning their interests with shareholder goals. They also reduce employee attrition due to set vesting periods.
• Limitations: RSUs may lose value in declining markets, and employees are typically taxed when the shares vest, even if they don’t sell them immediately.

Stock options

Stock options give employees the right to purchase company stock at a set price, often referred to as the exercise or strike price, after a specified vesting period.

• Benefits: Stock options offer significant upside potential if the company’s stock price increases, motivating employees to contribute to long-term success.
• Limitations: They can be risky for employees if the stock price doesn’t rise above the strike price, leaving the options worthless.

Performance shares

Performance shares are awarded based on the achievement of specific business goals, such as revenue targets or profitability benchmarks. These shares often vest only if the predetermined goals are met.

• Benefits: These LTIs directly tie employee rewards to company performance, ensuring strong alignment between individual efforts and organizational outcomes.
• Limitations: The complexity of setting and tracking performance metrics can make these plans challenging to manage and communicate.

Deferred bonuses

Deferred bonuses involve setting aside a portion of an employee’s annual cash bonus for payment in the future, often contingent on continued employment or company performance.

• Benefits: Deferred bonuses balance short- and long-term rewards, providing immediate recognition while incentivizing future commitment.
• Limitations: Employees may perceive the delayed cash payout as less motivating, and the company must manage the financial liability associated with these deferred amounts.

How long-term incentive plans work

Long-term incentive plans (LTIPs) are designed to align employee rewards with an organization’s long-term objectives, encouraging sustained contributions to the company’s growth and success. Implementing an effective LTIP involves clear structuring and strategic planning. Below are key components of LTIPs that businesses commonly use:

Vesting schedules

Vesting schedules dictate when employees gain full ownership of the incentives offered through the LTIP. These schedules are often time-based (e.g., three to five years of service) or tied to achieving specific performance goals. Vesting schedules incentivize employees to stay with the organization through their vesting period, reducing turnover and ensuring long-term commitment.

Performance metrics

Performance metrics are measurable long-term goals that employees or the company must achieve for the LTIP to pay out. These metrics can include revenue growth, stock price performance, or other strategic objectives. Metrics ensure that rewards are directly linked to the organization’s success, motivating employees to focus on key priorities that drive growth.

Payout mechanisms

Payout mechanisms determine how employees receive their rewards. LTIP payouts may be in the form of equity, cash, or deferred bonuses, depending on the plan structure. Customizing payout mechanisms allows businesses to align LTIPs with financial and operational goals while meeting employee compensation preferences.

Examples of effective long-term incentive plans

LTIPs vary widely across industries and company sizes, tailored to address unique business goals and workforce dynamics. Here are two long-term incentive plan examples that showcase how these plans enhance employee retention and motivation:

Stock options in technology companies

Technology companies, especially startups and growth-stage firms, frequently use stock options as a key component of their LTIP strategy. Employees are granted the option to purchase company stock at a fixed price (the strike price) after a vesting period. If the company’s stock value rises, employees can benefit from the difference between the strike price and the market price.

Stock options align employees’ financial interests with the company’s success, encouraging them to stay committed and contribute to the organization’s growth. The prospect of significant financial rewards fosters loyalty and high performance.

Performance shares in healthcare organizations

Healthcare companies often implement performance share plans to drive innovation and improve patient care. Under these plans, employees are awarded equity in the company when they achieve specific goals, such as reaching research milestones, increasing patient satisfaction scores, or meeting revenue targets.

By directly linking rewards to measurable outcomes, performance shares incentivize employees to prioritize excellence in their work. These plans are particularly effective for motivating high-level contributors, such as researchers and executives, while fostering a results-driven culture.

External factors that influence LTIPs

The effectiveness of LTIPs relies on various external factors that HR leaders and executives should consider when designing these programs. Understanding and accounting for these influences can ensure LTIPs remain competitive, relevant, and aligned with organizational goals.

Market trends

Market conditions, such as shifts in industry pay practices or changes in employee preferences, can significantly impact an LTIP’s appeal. For example, a surge in demand for equity-based compensation in certain sectors may prompt organizations to adopt stock options or restricted stock units (RSUs) to attract and retain talent.

Staying aligned with market trends ensures that LTIPs are competitive and help position the organization as an employer of choice.

Economic conditions

Economic fluctuations, such as recessions or periods of growth, can affect a company's ability to fund LTIPs. In a downturn, businesses might need to adjust the structure or scale of their LTI plans to balance cash flow with employee engagement.

Tailoring LTIPs to economic realities ensures sustainability while continuing to motivate employees.

Competition

The intensity of competition for top talent within an industry can influence the design and generosity of LTIPs and other fringe benefits. In addition to salary benchmarking, companies operating in highly competitive sectors may need to offer equity-based compensation structures and incentive plans to stand out.

Competitive LTIPs can help organizations secure and retain key employees, especially in industries where skilled professionals are in high demand.

When do employees earn long-term incentive benefits?

Employees typically earn LTI benefits by meeting specific time-based or performance-based milestones. These rewards are designed to foster long-term commitment and align employee contributions with the company’s strategic objectives.

Time-based rewards

Time-based LTIPs, such as RSUs, follow a vesting schedule where employees gain access to their incentives after remaining with the organization for a predetermined period, often three to five years.

How it works: This approach encourages retention by requiring employees to stay with the company to fully realize their rewards. The longer the tenure, the more benefits they unlock.

Performance-based rewards

Performance-based LTIPs are tied to achieving specific company or individual goals, such as hitting revenue targets, improving operational efficiency, or increasing market share. Employees earn rewards only when these predefined metrics are met.

How it works: Unlike time-based rewards, performance-based plans focus on results rather than tenure. This structure motivates employees to contribute to the company’s success actively and effectively.

Combining both time- and performance-based criteria is a common strategy, ensuring LTIPs promote retention while driving the organization toward its long-term goals. These structured timelines and triggers ensure that employees remain engaged and aligned with the company’s vision. 

Who benefits from long-term incentive plans?

LTIPs in the form of equity compensation are becoming an increasingly common part of salary packages at startups. Outside of the startup world, LTIPs are typically reserved for employees in critical roles where their contributions have a significant impact on the company’s success. These plans are designed to reward individuals whose efforts align closely with organizational goals.

Senior executives

LTIPs are an important part of executive compensation. According to the 2024 Pearl Meyer report, 97% of public companies and 68% of private companies grant LTIs to senior executives. These leaders are instrumental in driving growth and navigating the organization through challenges. LTIs align executives’ financial incentives with the company’s long-term objectives, motivating them to prioritize sustainable success.

Key roles

Aside from executives, employees in specialized or high-value positions, such as top salespeople, technical experts, or department heads, often receive LTI awards. Their unique skills and contributions are essential to achieving the company’s strategic initiatives. Offering LTI awards like equity or deferred compensation to key roles ensures that critical talent remains committed to the organization, reducing the risk of turnover in positions that are difficult to fill.

High performers

LTIs may also be extended to high-performing employees who consistently exceed expectations and contribute significantly to the company’s goals. These plans act as a reward and recognition for exceptional work. Recognizing high achievers with LTIs fosters loyalty, motivates continued excellence, and signals that the organization values and invests in top talent.

By targeting these groups, LTIs become a strategic tool for retaining vital employees, driving long-term results, and maintaining a competitive edge in the marketplace.

Common mistakes to avoid with long-term incentive plans

Designing LTIPs can be complex, and certain pitfalls can undermine their effectiveness. Here are three common mistakes businesses should avoid when creating LTIPs:

Overly complex plans

Plans that are too complicated can confuse employees and reduce the motivational impact of the incentives. Complex structures, unclear metrics, or difficult-to-understand vesting schedules can leave employees uncertain about how they benefit from the program.

Solution: Keep LTIPs simple and transparent, with clear guidelines and straightforward terms that employees can easily understand and appreciate.

Misaligned metrics

When the performance metrics used in an LTIP don’t align with the company’s strategic objectives, the plan may incentivize behaviors that are counterproductive or don't deliver desired results. For example, focusing solely on short-term metrics might negate long-term value creation.

Solution: Carefully select metrics that align with the organization’s long-term goals and measure meaningful contributions to business success.

Inadequate communication with employees

Failing to effectively communicate the details and benefits of LTIPs can lead to disengagement and a lack of trust in the program. Employees may not fully understand how the plan works or how it aligns with their roles.

Solution: Provide clear, consistent communication about the LTIP’s purpose, structure, and potential rewards. Regular updates and opportunities for questions can enhance transparency and employee buy-in.

By avoiding these common pitfalls, businesses can design LTIPs that effectively motivate employees, align with company goals, and deliver lasting value.

Best practices for designing long-term incentive plans

Designing an effective LTIP requires careful consideration to ensure it drives the right behaviors and aligns with both employee and company objectives. Here are some best practices for HR leaders and executives when creating LTIPs:

1. Align plans with company goals

The LTIP should reflect the company’s long-term strategic objectives, ensuring that the incentives motivate employees to contribute to those goals. Whether the focus is on growth, profitability, or innovation, the plan must be designed to drive performance in these key areas. Regularly review your company’s strategic goals to ensure the LTIP evolves with changing priorities and market conditions.

2. Select the right metrics

The metrics chosen to determine incentive payouts should be meaningful and tied to the company’s success. Whether based on financial performance, operational targets, or individual achievements, the metrics must be realistic, measurable, and within the employee’s control. Balance both financial and non-financial metrics to capture a holistic view of employee contributions.

3. Ensure fairness

LTIPs must be equitable to maintain employee morale and engagement. Ensure the rewards are proportionate to the level of responsibility, with senior roles having more substantial incentives while still offering competitive rewards to high performers at all levels. Consider the diversity of roles in your organization and create tiered plans that are appropriate for different employee levels.

4. Communicate the plan clearly

Transparency is key to an effective LTIP. Employees need to fully understand the criteria for earning rewards, the timeline for payouts, and how their efforts contribute to the company’s success. Provide clear documentation, hold informational sessions, and offer ongoing communication about the plan’s progress and goals.

5. Monitor and adjust regularly

An LTIP should be regularly assessed to ensure it remains relevant and effective. Business conditions, employee feedback, and market trends may necessitate adjustments to ensure the plan continues to motivate employees and align with business goals. Use performance data and employee feedback to refine the plan periodically, making sure it adapts to any changing circumstances.

By adhering to these best practices, companies can design LTIPs that not only motivate employees but also foster long-term loyalty, improve performance, and drive business success.

Streamline LTIP management with Rippling

For LTIP management so simple it’s almost effortless, you need Rippling.

That’s because Rippling has the only performance management software that’s powered by your employee data, allowing you to connect every step of performance management across the entire employee lifecycle.

Rippling’s workforce management system is built on a single source of truth for employee data. That means you can start by aligning your entire team around the right performance goals, using HR metrics to set objectives that are ownable, trackable, and measurable. Report on performance alongside all your employee data to unlock deeper, more impactful insights.

When employees reach their goals or hit the milestones required for LTIPs, your team can collaborate on promotions, raises, and other rewards—and compensation changes effortlessly sync to payroll.

FAQs about long-term incentive plans

What is LTIP compensation?

LTIP compensation refers to the rewards provided to employees under a long-term incentive plan (LTIP). These rewards are typically equity-based (e.g., stock options or restricted stock units) or cash bonuses, and are tied to long-term performance goals or milestones, such as multi-year financial targets or strategic objectives. LTIP compensation is designed to motivate employees to stay with the company and contribute to its long-term success, aligning their interests with those of shareholders or the organization as a whole. Unlike short-term incentive plans, LTIPs reward sustained performance over a longer period, generally spanning three to five years.

Are LTIPs only for executives?

No. While LTIPs are often associated with executive compensation, they can also be offered to employees in key roles or high performers across various levels of the organization. Companies may offer long-term incentives (LTIs) to employees who are critical to the company’s long-term success or who hold specialized skills.

How are LTIs taxed?

LTIs are taxed differently depending on the type of incentive. For instance, equity-based LTIs like stock options and restricted stock units (RSUs) are typically taxed when the employee sells the stock or when the RSUs vest. In general, LTIs are subject to income tax at the time of payout or vesting, and may also incur capital gains tax depending on how the rewards are realized. It’s important to consult with a tax advisor to understand the specific tax implications for each type of LTI.

Can small businesses offer LTIs?

Yes, small businesses can offer LTIs as part of a compensation plan, though they may not have the same resources as larger companies to offer extensive plans. Small businesses can structure LTIPs with more flexibility, such as through stock options or profit-sharing plans, to align employee interests with business growth. Offering LTIs can be an attractive way for smaller companies to give employees a sense of ownership and retain key talent.

Is an LTI the same as a bonus?

No, LTIs are distinct from cash-based bonuses. Bonuses are short-term compensation programs typically based on meeting immediate performance targets or achieving quarterly goals, whereas LTIs are long-term incentives tied to performance over a longer period, such as several years. LTIPs are designed to encourage sustained performance and align employees with the company’s long-term objectives, while bonuses tend to focus on short-term achievements.

What is a short-term incentive plan?

A short-term incentive plan (STIP) is a compensation plan designed to reward employees for meeting specific performance goals within a short timeframe, typically within one year. STIPs often include cash-based bonuses, commissions, or other immediate rewards that are based on individual, team, or company performance. These plans focus on achieving short-term objectives, such as hitting sales targets, improving productivity, or completing specific projects. While STIPs incentivize quick results, they differ from LTIPs, which are designed to align employee rewards with long-term company goals and performance.

How are LTIPs paid out?

LTIPs can be paid out in several ways, depending on the plan’s structure. Common payout methods include stock grants, stock options, or cash-based bonuses. For equity-based LTIPs, employees typically receive the payout when specific conditions, such as vesting or performance milestones, are met. For cash-based plans, payouts may be triggered by the achievement of financial or operational goals.

This blog is based on information available to Rippling as of December 9, 2024.

Disclaimer: Rippling and its affiliates do not provide tax, accounting, or legal advice. This material has been prepared for informational purposes only, and is not intended to provide or be relied on for tax, accounting, or legal advice. You should consult your own tax, accounting, and legal advisors before engaging in any related activities or transactions.