How Can You Maximize Benefits of Total Compensation Package?
There is more to executive pay than salaries, bonuses, and common benefits such as health insurance, retirement accounts, and vacation time. Deferred compensation and stock options are integral to the total compensation package.
With a wide array of incentive programs ranging from restricted stock to stock options and deferred compensation, how are you supposed to maximize your benefit? The first step is understanding your options.
What Are Restricted Stock Units?
Restricted stock units are some of the safest total compensation packages. With a restricted stock unit compensation package, you receive shares of your company. The safety of a restricted stock unit comes in its certainty, which you leverage control to gain. You’ll receive your shares on a vesting schedule that your former employer determines.
The vesting schedule under which you receive your shares often aligns with the amount of time you spent with your company, performance metrics, and other restrictions your former employer may impose. You’ll receive the shares incrementally over a given period. Once you receive your shares, you’ll have voting and dividend rights. The dividends report as wages on a W-2, and you’ll be taxed at the shares’ market value at the time of vesting.
What Are Stock Options?
While employee stock options are similar to restricted stock units, you maintain more control over these stocks when you receive and sell them. When your company gives you a stock option, you have the right to buy stock in the company at an agreed-upon rate and time window. Employee stock options are call options, meaning they assume the stock will rise over time. You’ll receive the most benefit if the stock’s value rises above expectation.
Employee stock option taxation occurs when you exercise and sell the option. They do not include dividends or voting rights.
What Is Deferred Compensation?
As the name suggests, deferred compensation is a package where the employer agrees to pay a portion of the employee’s compensation later. A retiring employee may receive different compensation as a part of a retirement plan or pension plan.
Deferred compensation plans like 401(k)s and 409(a)s involve matching systems where the employee and employer each contribute financially until retirement when the employee can access the money. In many cases, taxation occurs when the deferred income is paid out, which can be beneficial if you anticipate dropping to a lower tax bracket when you retire. 401 (k) plans are the exception — taxation occurs when you earn the income.
How to Maximize Benefits of Total Compensation Packages
If you are participating in a total compensation and benefits package, there are a few strategic elements to consider.
Create a Financial Roadmap
Before making a haphazard decision, create a financial roadmap. Detail your financial goals, viewing your finances holistically. Accounting for 401(k)s, IRAs, brokerage accounts, stock options, and deferred compensation allows you to quantify the impact of a singular decision on the aggregate portfolio.
For example, if you are participating in an Incentive Stock Option Program (ISO), there isn’t a taxable event at the exercise date; however, it is important to understand the exercise is calculated into the Alternative Minimum Tax (AMT). Additionally, if the stock acquired through the exercise is sold prematurely – within one year of the exercise date or two years from the grant – the favorable capital gains rate is lost and subsequently increased to earned income rates.
A more simplistic example occurs when an executive has stock options and a deferred compensation program. If the executive has the ability to spread liquidity events over separate calendar years, the potential to avoid reaching higher tax brackets exists. The real question is which do you liquidate first, the stock option or the deferred compensation? There isn’t a cookie-cutter answer; it varies per each executive’s unique situation. The executive must consider account values, the impact of taxation, and the potential risk versus reward.
Through a combination of deferred compensation and stock options, typically a large portion of a corporate executive’s net worth directly correlates to their company. This is not by accident; in fact, this is by design. While there is a fiduciary responsibility to the shareholders of a public company, tying an executive’s wealth to the corporation aligns the success of the business to its financial prosperity.
Create a Sustainable Investment Policy
An additional benefit of constructing an objective financial plan is the ability to create a suitable Investment Policy – a clearly defined investment approach based on income needs, time horizon, and risk tolerance. A key advantage of an Investment Policy is determining the appropriate diversification of assets. Strategically planning the liquidation of stock options throughout your tenure spreads taxation over multiple years reducing your exposure to a singular asset and the potential volatility.
Follow the Yellow Brick Road?
While devising a financial road map is important, it’s not as simple as following the yellow brick road. Flexibility is vital to your success. Readdress the plan as individual circumstances morph, tax laws change, and the financial markets fluctuate. An unexpected buyout offer not included in the financial plan warrants a discussion with your investment advisor to determine if the proposed package and current asset base are capable of sustaining the required income to maintain your current lifestyle.
Coordinate With Trusted Advisors
Be mindful of the one-stop-shop advisors claiming expertise in every facet of your financial journey. At this stage in your life, you have achieved the level of success where you are facing multiple, and often complex, financial challenges that necessitate specialists for investment management and tax advice.
With the current volatility in the market and ever-changing taxation landscape, it is impossible to remain an expert on both fronts. By segregating the investment advisor and tax advisor, you have effectively created a team of experts working on your behalf. Both provide professional insight from differing vantage points and add a layer of checks and balances.
The oversight of two experts ensures you are optimizing investment opportunities and tax advantages, which becomes extremely critical during retirement. Charging an independent investment advisor to produce income from your portfolio and coordinate with your tax advisor to take advantage of different account registrations to create the ideal blended tax rate in retirement is paramount.
Talk With a Financial Advisor
Whether you’re planning the last few years of your career or just began saving for retirement, a knowledgeable financial advisor can help you understand your options and execute a well-crafted retirement strategy. Fort Pitt Capital Group proudly offers Wealth Management and Financial Advisory services that help people reach their retirement goals.