Executive Compensation: 4 Perks and Pitfalls
Attracting executive talent is crucial for an organization’s success. A key factor that can impact the attractiveness of the offer is the total rewards package which is significantly more complex than pay structures earned by staffers further down the corporate ladder.
Early in your career, the bulk of your compensation most likely came from your salary (guaranteed compensation). And as you advanced up the executive ranks, your salary became a smaller portion of your total compensation with variable components (bonuses, stock, and other incentives tied to individual performance or company goals) becoming a larger portion of your overall compensation.
Typically, the perks that come with variable compensation can be accompanied by pitfalls that can make the road to economic freedom less than a straight path. Below are four common types of executive compensation. It’s important to note that executive compensation plans will vary from company to company and can even vary by different employee bands, underscoring the importance of working with a trusted advisor.
Cash Bonuses
Almost all executives will have a bonus target, typically a percentage of their salary. It is important to know and understand the metrics that will drive this payout and what percentage of target these can achieve. Also, because the tax withholding on bonuses will vary based on amounts, it is important to review your withholding with your CPA and Advisor to help avoid any surprises at tax time.
Restricted Stock Units (RSUs)
RSUs provide executives with company stock that vests over time or upon the achievement of specific performance milestones. Executives gain ownership rights after the vesting period, aligning their interests with long-term company success. The value of the award is included as ordinary taxable income at vesting. Future growth of the shares is subject to capital gains taxes with the purchase date being the date of vesting and the cost basis being the share price at vesting. Although the company may withhold a number of shares, highly compensated executives may still face an unexpected tax liability when filing tax returns. RSUs should be discussed with a trusted CPA or Advisor.
Stock Options
Stock options can be qualified, or non-qualified options based on the design of the company plan. Each has different tax consequences, making it important to understand the components of the plan. Option plans differ from Restricted Stock in that options are granted at a strike price and can be exercised at any time between vesting date and expiration. Stock options can expire worthless if the current value of the company stock is less than the grant price. It is also important to understand if the company offers a cashless exercise which can impact your need to bring cash to the table.
Deferred Compensation Plans
Deferred compensation plans generally come in two different forms: qualified and non-qualified. A qualified deferred compensation plan complies with the Employee Retirement Income Security Act (ERISA) and includes 401(k) and 403(b) plans. These plans allow employees to defer a portion of their compensation on a pre-tax basis into an account that is later taxed upon withdrawal. Qualified deferred compensation plans can be the bulk of a typical employee’s retirement savings. Companies can also offer non-qualified deferred compensation (NQDC) plans that are written agreements between the employer and the employee in which part of the employee’s compensation is withheld by the company, invested, and then given to the employee at a future point. NQDC plans are not subject to the protections of ERISA and balances can be at risk. It is very important to understand the terms of a deferred compensation plan before deciding to contribute.
There are several other factors that will play into total executive compensation such as the company’s insurance options, potential severance packages should employment be terminated, and executive perks such as use of company assets like memberships or planes. It is important to understand the level of access, ability to share with family members, and how these are treated for tax purposes.
Understanding the intricacies of executive compensation and benefits is crucial for optimizing a financial plan and maximizing overall compensation. Often, the granting of RSUs or options can lead to the bulk of wealth being in a concentrated stock position. This poses a risk but can be managed with a well-designed strategy involving calls, puts, exchange funds, or others. Another planning consideration with variable compensation includes the range of possible outcomes, underscoring the importance of working with a trusted advisor to design scenarios covering the range of possible outcomes.
Just as each person’s financial situation is unique, so are their company’s compensation plans. If you are not already working with Mercer Advisors, and would like more information, contact us.
