In my previous positions and just through a lot of reading on executive compensation, we’ve developed an expertise. So any of you listening out there that have executive compensation like RSUs, restricted stock, NSOs or ISOs, you want to give us a call so we can evaluate whether not you are maximizing your wealth potential and saving yourself money in tax liability. Today, I’m going to share a little parable that gives a high-level overview of how we help our clients.
In previous articles, we’ve have mentioned the importance of having a specific strategy to maximize your wealth building potential through executive compensation program. In our practice, we notice many highly-skilled and hard-working professionals don’t maximize their executive compensation programs either due to lack of knowledge or lack of time. This article will focus on some of the strategies that can be utilized in order to not incur unnecessarily high taxable income in any given year that awards are given, exercised or vested. To illustrate a specific strategy we will use the parable of Ron Smith.
The Parable of the Two Business Executives (6:00)
Ron Smith is the vice president of sales for MegaPharma, Inc. a thriving pharmaceutical company based in the US. Ron has been with the company for nearly fifteen years and has experienced great success. Such success he is now contemplating hiring a financial professional to help him manage his finances. Before this time he had managed pretty well he thought, at least according to his peers, but the events of the past six months have caught his attention. About seven months ago, his close friend and fellow colleague, Bruce Davis, who works for AlphaBioTech was laid off after serving his company for ten consecutive years. That was bad news indeed, but Bruce was a great saver and his wife works also so they would be fine financially. The real problem was what Bruce shared with Ron during a pharma conference they attended together.
Several weeks go by and Ron meets with Bruce’s financial advisor. The financial advisor uncovers several things.
Ron has 4 wealth building tools that are offered to create retirement income:
Defined Contribution Profit Sharing Plan or “401(k)”; The company matches up to 6% dollar for dollar (see episode 42)
Defined Benefit Cash Balance Pension Plan; The company contributes 7% of Ron’s salary to the plan annually
Restricted Stock Units; These have a 3-year vesting schedule
Non-Qualified Stock Options; These have a 3-year vesting schedule and 10-year expiry
The Advisor has also noticed a high concentration in MegaPharma’s stock across these 4 accounts
Ron is currently in the 33% tax bracket and concerned with his new salary and bonus he will be in the highest bracket of 39.6%
Three Planning Strategies (17:22)
After review, the financial advisor advised Ron to employ these three strategies to help Ron.
1) He recommended that Ron avoids exercising his options until after he had earned enough income year-to-date to avoid paying social security taxes and thereby reducing his take home pay. This will put 6.2% back into his pocket.
2) After creating a schedule of all Ron’s RSUs and NSOs, an exercise schedule was created to incorporate a system to “average-out” selling company shares to diversify his retirement portfolio. This minimized taxes while taking into consideration historical company share performance, Ron’s risk tolerance, and his financial goals.
3) Transfer property out of his estate by donating to a charity and use the subsequent tax deduction received to offset some of the W-2 income tax generated at exercise.