Executive Compensation Opportunities & Challenges
Golden Handcuffs are handsome rewards (the gold) with constraints (the handcuffs). Business leaders love and hate them. Your heart can grow much fonder of them if you leverage them to contribute to a bright financial future through proper planning, proactive strategies and purposeful execution.
Corporate leaders’ total annual compensation can vary by 200 to 300 percent or more from year to year. This volatility is a result of the sundry forms of remuneration received, each paying at differing times, in differing amounts, for differing reasons. These include regular cash compensation and bonuses, but can also include various forms of deferred compensation vehicles like traditional 401(k) and 403(b) tax qualified plans to non-qualified Supplemental Executive Retirement Plans (SERPs). Added to this mix can be stock awards, grants and options.
It can be complicated to consider all these components and how the decisions you make will affect your personal financial goals. You may wonder, how can I make smart decisions when I can’t predict what my total annual compensation is going to be each year? There are steps you can take now to leverage your success for the long-and short-term. For example:
Deferred Compensation Plans are great ways to avoid paying unnecessary income taxes now and take advantage of compounding. It pays to maximize what you put into your traditional 401(k) or 403(b) type plan and SERP. When you take $1,000 home in your paycheck, you only have $600 left to invest after income tax at the maximum bracket. When you put it in your 401(k), all $1,000 gets invested. That’s 67 percent more money right out of the box!
Stock Grants and Awards can range in size and amount depending on the performance of the company. Once they vest, their fair market value can be included in your income. With a publicly traded company, you may be able to sell a few of your newly vested shares to provide the funds necessary to pay the related income tax. But, if they are restricted in any way, you may have to look to other resources in order to come up with the related income tax, such as your cash reserves or borrowings from a bank.
What About Your Stock Options?
Should you exercise them as soon as they vest? Or, wait until closer to their expiration? Or, exercise the options now, but hold onto the acquired stock? What are the tax consequences of various decisions?
The answers greatly depend on the future direction of the per share value of the stock. If the stock is rising, you may want to delay their exercise. But if the current price is high and it may be going down, you may want to exercise your options right away, while they are still “in the money.” You may want to sell the newly acquired shares. With a 10(b)5-1 plan, there are ways to work around the many rules and limitations about selling company shares. Ask your advisor if it will work for you.
These layers of compensation-related decisions all contribute to the amount that will be shown as taxable gross income on your W-2, and directly affects the amount of income tax you will owe. If you are not paying close attention, you can have two or three of these items happen in any given year causing a spike in your taxable income, subjecting you to higher marginal tax rates than if your income was more smoothed out.
For instance, the company does well so your cash bonus is larger; you vest in a stock award and you exercise some stock options before they expire. Suddenly you are paying over 40 percent income tax on much of your income! If these could have been spread over two or three years, you may have been able to pay tax at a lower rate on the same income.
What’s The Solution?
It helps to have a financial plan that is updated frequently. It could contain three future wealth projections (best, worst and most likely case) and consider your current, deferred and stock-based compensation. That way, you can determine how much money you will need to achieve your financial goals and if you will reach your goals at current company performance levels. You will clearly see how each part of your compensation package contributes to your wealth accumulation targets. This knowledge will help you to confidently enjoy the wealth you’ve worked so hard to earn!
Tom Kirk is president, founder and WealthCoach at FirstWave Financial in Satellite Beach, Fla.