4 Financial Considerations Unique to Corporate Executives

1. Stock Options

   • Stock options often account for a substantial portion of employee compensation. By doing so, the company is aligning your compensation with the performance of the company therefore incentivizing key employees to do what is best for the company and, therefore, themselves. 
   • Why are stock options so good? Leverage. 
     • If the value of the underlying company stock goes up by 10% and the value of your stock options goes up by 20%, you have leverage. Its why stock options provide immense wealth creation potential. 
   • Remember, though, leverage works in both directions. It amplifies movement both up and down. So, it’s important not to let a single stock dominate your financial picture.
     • Executives often have a feeling – labeled the Fallacy of Control – that they have greater control over the stock price because they’re close to the business. Sometimes it’s simply a feeling of having greater insight into the business that stokes the coals of overconfidence. Whichever it is, it’s important to overcome the feeling that you can control, to any substantial degree, the ultimate fortunes of your stock’s value. Think about if you didn’t work for the company. Would you still allocate 20% of your net worth to one single company, namely yours?
   • When is the right time to exercise? 
     • Stock options vest over time; they must be above the grant price to have any value; and they expire at some point in the future. There are many considerations - grant price, expiration, taxes, cash needs, and concentration - that come into play with stock options. While you want to take advantage of the leverage provided, it’s important to have a plan in place to limit taxes, reduce concentration, and protect yourself from having to exercise when the stock price may be depressed.  
   • Qualified Small Business Stock.
     • If you work for a startup, the stock issued to you as a founder or early employee/investor may be classified as Qualified Small Business Stock. In this case, if held for 5 years (post-exercise), you may be able to sell your stock without owing capital gains tax on the greater of 10x the adjusted basis or $10 million.

2. Restricted Stock Units (RSUs) 

   • Like stock options, RSUs are company shares granted to key employees under a vesting schedule (hence, restricted). Unlike stock options, you don’t choose when you exercise those shares. When RSUs vest, taxes are withheld, and you receive the net shares. That’s one less decision, but then you need to decide if you should hold onto the shares or sell them. 
   • Remember, you owe taxes in the year they vest and those taxes – or at least a portion of them – have already been withheld. Often, it’s best to think of these shares as income; selling to produce cash to support lifestyle expenses. That opens other avenues to save in a tax-deferred manner such as increased 401k contributions or a deferred compensation plan. Immediately selling the acquired shares also provides the added benefit of limiting your concentration in company stock. Remember, if you own stock options as well, that’s where you’ll get the greatest leverage if you’re bullish on your company.

3. Employee Stock Purchase Plan (ESPP)

   • An ESPP allows employees to purchase shares of company stock via automated payroll deductions at a discount. Shares are typically offered at a discount to the lower of the opening or closing price of the offering period. For example, if your company offers a 15% discount and the value of the stock is $10/share at the beginning of the offering period and $15/share at the end of the offering period, you receive the shares for $8.50. By participating, you’re getting a head start on returns. 
   • Now, in most plans, you’re not able to turn around and sell that stock immediately. Most require the participant to hold the shares for a year before selling. This introduces the risk that shares will decrease in value but remember, you already got a 15% head start. If you’re not participating in the ESPP, you should consider it. When your shares hit the one-year mark, take your returns with a head start and diversify. 
   • Remember, be careful of concentration. You’re getting company shares from a multitude of sources – RSUs, Stock Options and the ESPP. 

4. Deferred Compensation

   • A non-qualified deferred compensation (NQDC) plan allows an employee to earn wages, bonuses, or other compensation in one year but receive those earnings, and pay income taxes in the future.
   • To illustrate the idea, suppose you’re currently in the 37% marginal bracket: currently everything over $622,051 for a married couple filing jointly. An executive defers $150,000 of income that would have been taxed at 37% this year and elects to receive that income in equal $30,000 installments in the first 5 years of retirement. Now let’s say you do that each year for the next 5 years. In the first 5 years of retirement, you will have $150,000 (assuming no growth or loss) to support your retirement spending. On top of that, half of that income will be taxed at a rate lower than 22%!

A client recounted a conversation with a more senior executive which lead to his decision to hire an advisor. The executive said there were too many decisions for him to think he could do it alone. His message was – “you’re successful now too; you deserve to have help”.