When it comes to planning for retirement, there is no one-size-fits-all approach. Everyone has different amounts of accumulated wealth, various family dynamics, legacy planning needs, personal goals, and many other financial considerations. One other reason why everyone’s financial plan and retirement strategies differ is that their personal vocation creates unique needs and circumstances that must be addressed in their plan.
Corporate executives in particular have spent their career building companies, shouldering responsibility, and leading teams. They’ve dedicated much of their life to their job and need someone to help them take care of their future as they take care of their company’s future. In addition, as high-income earners, their financial planning needs are more complex than others. If you are a corporate executive and are uncertain about how to plan for your retirement years, here are some solid principles to help you on your journey.
1. Sock It Away
This may seem obvious, but the more you earn, the more you should be saving as much as you possibly can so you have a chance to maintain your lifestyle throughout your retirement years. This is even more important considering that the average senior executive’s tenure is only five years at one company and it typically occurs in their mid-50s. (1) The five to ten years before retirement tend to be your peak earning years and this is the time when you should drastically increase your savings rate.
Since executives often fall under the IRS’s “highly compensated” category, they might not be able to maximize the full benefits of a company 401(k) plan or their income may dis-qualify them for a direct Roth IRA contribution (although, ask us about a “Backdoor Roth IRA). Also, if you own more than 5% of the company or earned more than $120,000 in the previous year, you are considered “highly compensated” (2) and will hold you to certain contribution limitations. Many companies, in order to help their executives save for retirement, offer a Supplemental Executive Retirement Plan (SERP), which is a non-qualified plan that does not have required minimum distributions or tax penalties if you tap into it before you turn 59½.
SERPs can take the form of deferred compensation plans, executive bonus plans, or a cash value life insurance policy. Research your savings options to maximize your retirement nest egg.
2. Maximize Your Stock Options
One of the benefits of an executive position is that you probably have amassed a high amount of company stock during your tenure. Stock options can be an incredible asset, but they can also be complicated to deal with and tricky to manage. When it comes to handling and exercising your stock options, keep these three ideas in mind.
A. Watch Taxes
Perhaps the biggest determining factor for the end-value of your stock options is taxes. It’s important to understand how stock options are taxed so that you can minimize your tax liability.
1. How Stock Options Are Taxed
There are generally two kinds of stock options, Incentive Stock Options (ISO) and Non-Qualified Stock Options (NSO). The main differences are who can receive them and how they are treated for tax purposes. When NSOs are exercised, the difference between the grant price and the fair market value of the stock (called the “bargain element”) is taxed at ordinary income rates. Then, when the stock is later sold, the gains are taxed as either short- or long-term capital gains, depending on how long they were held. ISOs receive favorable tax treatment because they meet certain requirements in the Internal Revenue Code. Unlike NSOs, the exercise of an ISO is not a taxable event, though it could trigger the Alternative Minimum Tax. If the shares are immediately sold, the “bargain element” is taxed as regular income. Holding onto the shares is how you can get the tax break. Everything (the bargain element and the gains) is taxed at the long-term capital gains rate if you hold the shares for at least a year after exercise and do not sell them for at least two years after the grant date. (3)
2. Filing An 83(b) Election (4)
If your company stock is growing steadily, it might be a good idea to file an 83(b) election. An 83(b) election, which is typically used for stock grants (not option grants), simply allows you to pay the income taxes due at the grant date instead of the exercise date. You need to file for this election within 30 days of the signed agreement date.
For example, let’s say you are granted stock options at $25 and the price when you exercise them is $50. With an 83(b) election, you pay income taxes up front on the $25 cost. Any growth from there is taxed as capital gains when the shares are sold. Without the election, you pay regular income taxes on the $50 price when you exercise the options. The election allows you to pay half as much at the regular income tax rate and push the gains made between granting and exercising into the lower capital gains tax rate.
Filing an 83(b) election can be beneficial if the value of your company stock is increasing steadily. However, if the prices drop or the company goes out of business, you will be worse off for having filed. There are many complex rules that pertain to this technique, so coordination with your advisor team is critical before taking action.
3. Smoothing Taxable Income
It’s important to coordinate your taxable events relating to employee stock options. Proper planning for income taxes generated from exercising options ahead of time can be extremely valuable to you. Smoothing taxable income over time to stay out of high marginal tax brackets can save thousands in taxes.
B. Get Organized
If you’re like many executives, you have received a variety of restricted stock and stock options at different times and for different amounts. The restricted stock may have very different vesting dates than the stock options, and the options may expire at surprising times as well. With so much going on, it’s easy to miss a deadline. A lot of people’s stock options expire because they plan to exercise them at the last minute only to get distracted or simply forget. Not exercising your valuable stock options is like throwing away money.
Being organized is crucial if you want to make the most of your company’s stock benefits. There are strict deadlines if you want to take advantage of some of the tax savings listed above. Don’t leave money on the table. Staying on top of dates and amounts can save thousands in taxes and help avoid missing out on expired options. Haddon Wealth Management has sophisticated software that can show you how to manage your restricted stock and stock options and we can help you make important decisions in a timely manner.
C. Reduce Risk By Diversifying
Employee stock options are a nice benefit, but you don’t want too much of your financial well-being tied up in one company. If the company performs poorly, it will depress the stock price and you could be laid off at the same time. There goes your portfolio, your income, and your health insurance – all at once! Unfortunately, history has many examples of this happening to corporate executives. Back in 1999 when Enron filed for bankruptcy, more than $1 billion in employee retirement savings simply evaporated. In 2008, many Lehman Brothers employees experienced the same thing during the financial crisis. (5)
As a corporate executive, you may have even more of your net worth tied to the stock of your company than other employees. You can diversify your investments by exercising your stock options or strategically selling shares of your stocks. If you have large amounts of company stock, work with a professional to make sure your decision to divest of your stock won’t hurt the company.
3. Understand Your Benefits Package
Most executives have options on how they can receive the payout of their deferred compensation plans, either through a lump-sum payment or an annuity payout. As you can imagine, your choice will have tax implications. If you elect to take a lump-sum payout, you will pay taxes on the full amount in the year you receive it, most likely pushing you into a new tax bracket, this is usually not a good idea.
However, your pension decisions will depend on your unique circumstances. You may choose to face the tax risk of a large lump-sum payout in order to invest the money for growth to help you manage inflation or provide money to your heirs. Many plans require participants to take their pension at 65 if they choose the monthly payments, so if you aren’t ready to retire, opting for a lump-sum payment gives you more control. You could also roll your pension payout into an Individual Retirement Account (IRA) if you don’t need the money right away. This could help you defer taxes on the proceeds.
On the other hand, a monthly annuity-like payment offers guaranteed, consistent income and provides diversification with your other retirement income, such as Social Security and personal investments. In some payout scenarios, your monthly annuity may only last as long you are alive. If you are in poor health, you may want to choose the lump-sum payment, whereas if you live a long life, your monthly payment could eventually exceed the lump-sum amount.
When it comes to making these decisions, gather all the details from your human resources department and work with a professional who can map out various scenarios to determine tax liability and future income needs.
4. Create A Tax Strategy
We’ve already discussed the tax implications of your stock options, but it’s also important to look at your overall income picture. As a corporate executive, you are most likely a high earner in a high-income tax bracket. Any additional income from exercising stock options, pensions, RMDs, or other investments could push you over the edge in terms of your tax bracket.
If you have a SERP, make sure you are aware of all the details so you don’t get hit with extra taxation or experience financial surprises down the road. Many SERPs have individualized conditions and allow you to choose a future payout date. When choosing the timing of your payout, keep the concept of tax smoothing in mind and stagger payout dates to spread the tax burden around.
A professional who has experience working with executives will be able to help you minimize your taxes while working to create a plan to lower your tax burden in retirement, all while taking stock options, pension, personal retirement savings, and other investment accounts into consideration.
5. Withdrawal Strategy
As an executive, you probably earn a significant amount of money. As you prepare for retirement, it can be difficult to transition from earning a large paycheck to living off the investments you’ve amassed. Creating a personalized withdrawal strategy, based on your particular needs and dreams, will give you peace of mind that your money will last as long as your retirement. A withdrawal plan will not only put a cash flow plan in place, but it will also help you minimize taxes by helping you draw from the right accounts, in the right manner, at the right times.
6. Work With A Professional
Financial planning can be complicated for anyone, but as a corporate executive, you have many other factors to consider. There are serious decisions to make, and the earlier you start planning, the better. At Haddon Wealth Management, we have the experience and expertise to walk you through each aspect of your retirement and help you take advantage of your corporate benefits. You have a lot on your shoulders, so let us help ease your financial burden by taking care of the details for you.
Whether you need to get started on your retirement planning or have questions about strategies that may work for you, call us at (856) 888-1744 or contact us online to schedule a complimentary get-acquainted meeting.
Gregory M. Hart, CFP® is the founder and managing director of Haddon Wealth Management, LLC, a registered investment advisory firm that provides comprehensive wealth management for clients who value a relationship-driven approach that delivers customized solutions. He seeks to address clients’ many financial needs in an integrated approach combining both investment management and financial planning which may include some or all of the following: detailed retirement planning using a year-by-year cash flow analysis, tax-minimization estate planning, Social Security decision analysis, education planning, and much more. Based in Haddonfield, New Jersey, Greg works with clients throughout the Delaware Valley, as well as nationwide. To learn more, connect with Greg on LinkedIn, visit our website at www.haddonwealthmgt.com, or call (856) 888-1744.