Effective Compensation Packages for Nonprofit Leadership

Compensation that fits organizational budgets and maintains market competitiveness is a concern for many businesses. And nonprofits face the added challenge of uncertain funding year to year. So, how do you start building an executive compensation program that attracts top tier leaders AND fits budget constraints? When determining competitive and fair compensation for executive leadership, we encourage boards to look at their total rewards package and make decisions by balancing four key factors: internal equity, market competitiveness, fiscal responsibility, and specific organizational context. Let’s dive in!

The Challenges of Determining Total Compensation for Nonprofit Leaders

We know that finding the right compensation for an executive director at a nonprofit comes with several challenges, many of which are unique to 501(c)(3) organizations. To start with, budgets are tight. Capital tends to be less prevalent in nonprofits, and what money there is is split across different organizational priorities. Funding in recent years has been harder to come by, with a nonprofit trends report finding that 76% of organizations either saw no increase in funding (41%) or saw a decrease in funding (35%) from 2022 into 2023. More recent data shows reason to hope funding will continue to grow for the 2024 and 2025 funding cycles, but nonprofits must determine compensation based on typical or tight years, and not exceptionally good ones, to be able to predictably compensate staff. Limited capacity is another challenge. Staff, leadership, and board members only have so much time, energy and resources in a day to understand and determine the nuances and levels of  executive compensation. Nonprofits also face 501(c)(3) specific legal implications for their executive pay, with the IRS stating that compensation be “reasonable” for the role. Values driven organizations should also consider equity implications: nonprofit leadership compensation has broader implications for organization-wide compensation, because how much you pay your leaders can and likely will impact how much you are able to pay your staff. One more challenge nonprofits face is balancing stakeholder priorities. Board members, leaders, staff and even funders have different priorities for how to allocate budget, which do not always align, and often compete. 

Finding Solutions: Equitable Compensation for Executive Directors and Other Leaders of Nonprofits 

The challenges nonprofits face when determining appropriate leadership compensation are not without solutions. However, before we look at the ways to take a balanced approach and determine total compensation for your executive team, we need to dive deeper into compensation types and legal considerations specific to nonprofits. 

Types of Compensation for Executive Directors 

There are three ways of considering compensation. One, base pay, is the minimum cash that an employee earns for their services. Total cash compensation (TCC) is the second way, and is the total amount of cash earned by an employee during a year of full time employment. This includes base salary, bonus, stipends and other forms of cash compensation, often called short term incentive pay. The third is total compensation which is the total amount of cash + benefits (health, retirement, etc.) paid to an employee. This includes base salary, bonus, stipends, health insurance, retirement contributions, and other benefits covered by the employer. When discussing leadership “pay” we really mean total compensation, and when we say executive director compensation throughout this blog, we’re referring to total compensation. 

• Legal Considerations (The Nitty-Gritty)

Nonprofits face different legal requirements than their for-profit counterparts. For starters, fiduciary laws require board members to put the interests of the nonprofit organization above everything else. IRS Code Section 4958 requires that nonprofits compensate their leaders in-line with the compensation at organizations of similar size and profit. Over-compensating can lead to both the compensated individual(s) and the board facing tax penalties. Lastly, nonprofits are required to fill out tax form 990 which compels organizations to disclose the salaries of their directors, key employees, and top 5 highest paid employees among others. These and other legal requirements must be considered when determining appropriate compensation of executive directors and other leaders at nonprofits. 

Best Practices for Executive Compensation at Nonprofits 

In order to meet the practical, legal, and ethical requirements of nonprofit compensation, boards and leaders should look to balance four things when designing compensation structures: internal equity, market competitiveness, fiscal responsibility, and specific organizational context. Each nonprofit will need to prioritize these four factors in different ways, while aiming for balance. Doing so ensures a workable compensation policy organization wide and will impact and guide the decisions boards make around compensation for executive directors and other c-suite leaders in their nonprofit. 

External Competitiveness and Organization Specific Context

When determining salary for executive directors, lean into the data. Use market data to determine competitiveness and compliance. Set parameters when looking at market data to benchmark against similar organizations; if you’re unsure how to do this, reach out. Edgility encourages triangulating data to arrive at a reasonable number, since even similar sized organizations can have wide variability in salary. Every nonprofit chooses different total compensation packages, making it important to take into account their and your specific organizational context and all components of compensation when determining the package you offer to your leaders. 

Internal Equity 

One way to ensure internal equity is to keep compensation in line across the organization. If you typically compensate at 50% of the market rate for your staff, do the same for your leaders. Another factor to consider is the pay ratio: nonprofits usually operate with a 10:1 ratio between the highest paid staff and the lowest. Very large nonprofits may have a larger ratio, but organizations of $100 million or less rarely will. 

• Expert Advice: If your organization chooses to provide bonuses as part of its leadership compensation, make sure to require an evaluation of the director. Even if bonuses aren’t a part of their total compensation, leadership evaluations are necessary to ensure your leader feels supported and is making the desired impact.

Fiscal Responsibility

Compensation packages that are developed without a full picture of what they mean for the organization will undoubtedly lead to strife and distrust. No organization ever wants to cut salaries, but those who do not plan responsibly may be put in that position. To avoid that, nonprofit fiscal responsibility in compensation must account for hidden costs. Factors such as payroll taxes and retirement matches influence the cost to the organization but can be forgotten about when making compensation decisions, specifically salary. Nonprofits must also make sure that what they are offering is sustainable in the long term. Baked-in increases will compound over time and nonprofit organizations need to do some forecasting to see if their budgets will be able to grow to meet future obligations and sustain their missions. 

The Objective of a Total Rewards Package for Executives 

Designing the right compensation for leaders at your organization means thinking in terms of the total rewards package. Whether you’re talking base pay or additional benefits and compensation, the same factors are paramount: attraction, retention, and equity. Organization-specific context is key when seeking to attract and retain executives. Who are you competing against? Is it similar sized organizations in similar sectors (nonprofit, charter schools, etc) or are you trying to pull from the for-profit sector? What do qualified candidates from that sector expect for compensation that will make you more competitive? And if you can’t afford it, do you offer a culture, mission or other benefits that will encourage the right leader to join your team?

Most leaders are used to thinking about equity in compensation in terms of ensuring that staff are paid fairly regardless of their identity and that the bottom of an organization is fairly compensated compared to the top. Interestingly though, equity is still very much an important factor leaders take into account when deciding to join an organization and should be something your team considers as they develop total rewards packages.There are several ways in which CEOs and Executive Directors receive unfair benefits. One common issue executives may face is unfair life insurance and disability insurance plans. Many organizations have insurance plans that cap total pay out. They may allow employees to have, for instance, a life insurance policy that is 3x their annual salary, provided that amount is less than $250,000.  These limits are set by the insurance provider, not the organization, but the end result is that executives and senior leaders do not qualify for a policy in line with what they’re earning. Part of your total rewards package might involve making up for these differences, rather than simply adding in extra rewards. 

Analyzing and Identifying Solutions for Total Rewards: Next Steps 

The first step in identifying solutions for your organization begins with clarity around your objectives and goals. Edgility recently conducted a webinar with the Marsh McLennan Agency on creating a total rewards compensation package for executive and senior leaders that can help you look at the full picture. We encourage you to watch the replay to dive deeper into this topic, particularly the excellent discussion around retirement benefits. When you’re ready to work with a partner who can guide you through designing a compensation policy for your organization and its leaders, contact the team at Edgility to get started.