Executives with equity compensation: Are you planning strategically?

For many executives — from those with very little invested to others with tens of millions on their personal balance sheet — today’s choices around executive compensation (particularly stock-based compensation) can be critical to meeting future financial planning goals. Where are you in the planning continuum?

Step one is understanding what you need to establish long-term financial independence. Your “financial independence number” is the amount of assets you need to support your lifestyle and long-term goals (i.e., spending, support for family, gifting/donating, etc.) and is the all-important starting point for financial planning. The following Q&A will help you understand some of the key opportunities to help attain, and preserve, your financial independence number.

Your “financial independence number” is the amount of assets you need to support your lifestyle and long-term goals.

How does a sizable position in company stock impact portfolio risk?

If company stock is a significant part of your compensation package, it can become a large percentage of your financial portfolio over time, which is a key contributor to your financial independence. However, while a concentration in one stock can provide a strong upside to your financial independence number, removing concentration risk from the picture is often a prudent move. If your financial independence relies on a highly concentrated stock position, it may be time to consider how much you should sell to ensure you’ll have enough in a diversified portfolio to support your retirement. If you decide to sell, determine whether you’re subject to a lockup period or other securities or legal restrictions that could prevent you from transacting the stock.

If you decide to sell, determine whether you’re subject to a lockup period or other securities or legal restrictions that could prevent you from transacting the stock.

Once you understand your financial independence number and your flexibility for selling, work with an independent financial advisor to consider planning ideas like 10b5-1 plans that allow insiders to sell shares under a prearranged plan and help avoid SEC-related issues.

What tax planning opportunities exist?

Mapping out expected income with your tax and financial advisors can be helpful. This may include salary, annual bonuses, deferred compensation plan payouts, expected option exercises, scheduled vesting of restricted stock units, and other methods. While future tax rates are always an unknown, as is income connected with stock performance, modeling a variety of scenarios can be a worthwhile exercise. Understanding projected income can allow for planning related to withholding, accelerating and decelerating deductions, and accelerating/decelerating income like deferred compensation, option exercises, social security, Roth conversions, and 83(b) elections that allow a restricted stockholder the opportunity to pay tax when the award is granted. Option exercises become especially important when working with incentive stock options (ISOs) given the triggering of alternative minimum tax. Your tax advisor can help you build a proactive strategy to exercise your ISOs with minimal tax consequences.

How does executive compensation impact investment strategies?

Investment planning is the art of balancing risk tolerance, needed rate of return, and time horizon. These factors help drive the decision on how much of your investment portfolio will be allocated to risk assets and how much should be allocated to safer assets such as cash and fixed income securities. Once this target investment plan is created, these targets will serve as the “goal posts” for the portfolio moving forward, allowing you to rebalance when one asset class is over or underweighted from your target allocation.

As mentioned earlier, some executives tend to have much of their personal financial picture connected with the stock of their company, and what’s received from cash bonuses, stock options, and restricted stock is often very dependent on what happens with the stock price. Investing strategies to reduce this exposure can include taking less risk in your nonqualified retirement accounts and/or hedging stock price risk through put options, zero premium collar strategies, variable prepaid forward contracts, and exchange funds. Other portfolio management strategies could include selling covered calls on your stock position for additional income. Working with your financial advisor will help find an approach that’s best for you. Once a plan is developed, it’s always important to consult with your company’s compliance department, to ensure the strategy you’re considering won’t run afoul of trading restrictions.

How can an executive compensation package impact your personal balance sheet?

Taking stock of your assets and liabilities by constructing a personal balance sheet allows you to see the big picture. This tool is a critical starting point and can provide value in allowing you to more easily identify areas that require action — either out of necessity or opportunity. Consider the following questions related to the executive compensation package component of the balance sheet and consult with your wealth planning advisor to help confirm answers.

• How much of my personal balance sheet is connected with my employer? Am I comfortable with this amount of diversification/concentration?
• How is the account that holds my shares titled (i.e., in personal name, joint name, or trust name)?
• Who are the beneficiaries on my qualified and nonqualified retirement accounts?
• Who are the beneficiaries of my employer life insurance policy?
• How much life insurance does my employer provide? Is this amount enough to support family goals if I were to pass, or is a supplemental policy necessary?
• Do I have enough property and liability insurance to protect my balance sheet?

Taking stock of your assets and liabilities by constructing a personal balance sheet allows you to see the big picture.

For those with larger balance sheets, wealth transfer should also be part of the planning discussion, particularly if your estate (net worth) exceeds the estate tax exemption that’s currently at $12.06 million per person, or $24.12 million for a married couple. If the value of your balance sheet is well in excess of your financial independence number, which is often the case when highly concentrated in a stock that significantly appreciates, additional planning considerations could include shifting assets and future growth outside of your estate. Your financial advisor can help you understand the many options available to achieve this outcome, including strategies such as the spousal lifetime access trust.

For more information on executive compensation planning feel free to reach out; we’re here to help.