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How do I trade off long-term incentives for short-term ones?

PhotonicsPays
Jan 2007

Q. I work for a company that pays me $72,000 a year with no bonus. However, they match 50 cents to the dollar on my 401(k) plan. The company I'm interviewing with has no matching contributions, but they have averaged bonuses of 11 percent over the past five years and 20 percent over the past three years. How should I calculate a base salary with bonus vs. my current base with no bonus?

A. Companies have a certain amount of money to spend on variable pay and/or benefits. The senior management of a company may value long-term investment higher than short-term incentives. And companies are more likely to invest in something they believe in. So it seems as though your current employers value long-term incentives over short-term ones. That's why they match 50 cents to every dollar you contribute to your 401(k) plan.

There really isn't a standard answer to your question. You have to decide what is more important to you: receiving a 401(k) match - which is like receiving free money - or an incentive payout that may or may not get paid out, particularly in a down market. The answer depends in part on how much you've been paying into your 401(k).

Let's use a table to think it through. First, we assume your base pay is the same with either company. Then we compare your expected total cash compensation if you receive the even the lower five-year historical average bonus and put the maximum allowable $2,000 into an IRA. Then we watch what happens to your current cash compensation if you contribute 5 percent or 10 percent to your current employer's 401(k) plan. Even without calculating account performance or taxes, it's easy to see that an expected bonus of 11 percent or more leaves you better off than you are now.

  11 percent bonus 5 percent 401(k) contribution 10 percent 401(k) contribution
Base pay $72,000 $72,000 $72,000
Voluntary deduction ($2,000) ($3,600) ($7,200)
Bonus/match $7,920 $1,800 $3,600
Total current cash compensation $77,920 $68,400 $64,800
Total compensation $79,920 $73,800 $75,600

If the company makes its numbers and is able to pay you a bonus commensurate with its historical average, you'll be better off on both a current cash basis and a total compensation basis by accepting the job with the incentive and putting the legal amount into an IRA, all else being equal.

Of course, the table does not take into account the tax consequences of contributing to a 401(k), nor the vesting period. And the numbers will be different if your new base pay is different, or if your bonus is different.

As you can see, the numbers can be run in a variety of ways. At a certain point, different compensation philosophies are a matter of values - the company's and yours.

Good luck.

- Erisa Ojimba, Certified Compensation Professional
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