Hartford Business Journal Ask the Expert Feature with Jarrett Solomon, CFP®
Q: What is an executive compensation plan and why do companies offer them?
An executive compensation plan is a form of payment outside of traditional salary/bonus for top-tier employees that awards performance with equity in the company in the form of stock or options. The purpose is to incentivize the performance of executives and align their goals with those of the company and its shareholders.
Q: What decisions should executives make this time of year?
We find it helpful to meet with our executives early in the year and plan for a year’s worth of stock activity. This way, we can set goals for how best to detach from an executive’s company equity while taking the near-term emotion out of the equation. Additionally, executives should watch closely for vesting dates, open windows, and holding requirements.
Q: With current market volatility, is there anything that should be top of mind for executives?
First, the decision on when and how to exercise stock awards is multi-faceted and is best driven by the
context that a solid, proactive financial plan can offer. Given the recent dip in stock prices and assuming all compliance requirements are met, exercising options at this time could likely lead to a lighter tax bill this year. Even if the executive remains optimistic about the company’s prospects, they could always exercise an option, hold the stock, and make future gains subject to a more favorable capital gains tax compared to ordinary income rates.
At CTWM, we often find that executives can get tied emotionally to their company’s performance and urge them to diversify away from the risk a single company can have on one’s overall financial plan, including future salary, bonus, and stock awards that have both vested and have yet to vest or even be granted.
Q: What are potential tax implications to consider?
Different types of executive stock awards are taxed differently. Restricted stock units are taxed immediately when the shares vest, while no tax is due when most stock options vest. Generally, we encourage our executives to sell their restricted stock as it vests since taxation will already occur, while the timing of option exercise, which constitutes taxable activity, can be pinpointed to try to capture the best value while keeping the tax bill as low as possible.
Executives can also watch out for an 83(b) election, which allows them to pay ordinary income tax on restricted stock at the time of granting. Pursuing this strategy results in future gains being taxed as capital gains, which can be a worthwhile strategy if the stock price is artificially low at the time of the grant.
Q: If planning on retiring soon, what preparations should be made?
Executives planning to retire need to have clarity and confidence that they have set aside enough assets to enjoy a comfortable retirement, even as markets fluctuate over time. Further, they must be aware of whether retiring means that they will sacrifice stock awards that were granted to them but have yet to vest. Oftentimes, executives participate in a deferred compensation plan that can pay out large sums of money upon retirement based on an election that might have been made years ago. To that end, the year-to-year fluctuations in a retiring executive’s compensation can be a great opportunity for a proactive financial advisor to minimize taxes by timing certain items either with the company
stock or elsewhere in the portfolio.
Q: How can a financial advisor help executives navigate this?
A good financial advisor can help you understand the complexity of executive compensation plans and keep your overall financial plan in context while making key decisions about how to benefit from these programs most effectively. Ask your advisor to come up with a plan to best diversify away from the risk of a single company while keeping the tax bill you send to Uncle Sam as low as possible.