Maze Every twist and turn has tax implications. You can help your clients navigate. (Image: Thinkstock)

One of the most complicated and misunderstood areas that financial planning professionals like myself confront on a regular basis is helping executives who benefit from stock compensation plans. Optimal maximization of this kind of compensation is a tactical consideration that is far too complicated for most individuals, even those with a good grasp of financial principles, to handle on their own.

Let me explain my position a little more clearly. Basic retirement planning is strategic. It requires looking at the big picture, and it entails ongoing behaviors such as saving a certain percentage of income every month or contributing enough to a 401(k) to maximize employer matching. But when it comes to equity compensation, which is just one component of the overall financial situation, decisions are tactical, and the timing of when moves are made is critically important. Getting the most out of an equity compensation package really depends on variable factors such as the price of the stock, the vesting date and the type of compensation that was granted.

Equity compensation is the umbrella term, but the specifics can range from stock options to restricted stock grants to incentive stock options to performance units, which are a relatively new form of compensation.

It’s hard to be tactical in this regard if you aren’t well-versed in the specifics of the plan or its tax implications. And even if you know what to do, being able to execute can be tricky. There are also questions of how the equity compensation meshes with the overall financial plan and its impact on tax liabilities, investment strategy, your insurance portfolio and estate plan. For most executives with this kind of compensation, working with a financial professional who is conversant with the ins and outs of equity compensation, as well as the portions of the tax code surrounding the different types of compensation, is essential. Getting the right advice can make all the difference between maximizing success and accepting mediocrity.

The simplest form of stock compensation is the equity option, where the stock is basically treated and taxed like any other bonus that the executive would receive. That sounds simple, but the option could be tied to specific time periods during the year when it must be exercised, and those times may not coincide with the best share prices.

If the compensation is in the form of a restricted stock grant, then taxes will be due upon the vesting of the grant. A professional advisor can counsel the executive on the most advantageous way to pay off the tax. It might make sense to sell enough of the stock to pay the tax on the rest, or if there’s an expectation that the stock price will rise, the shareholder could retain the entire grant and pay the tax from some other source.

Performance units are awarded based on the overall success of the company per pre-prescribed metrics, not just stock price. They represent a commitment by the employer to award a target number of shares (or the cash equivalent) at a future date, once vested. The actual number of shares varies based on performance relative to defined goals. Performance unit vesting can accelerate when the performance targets for the entire company are met. These have become increasingly popular as an incentive because everyone has a stake in a positive outcome, and it forces all the employees to be rowing the same direction.

Incentive stock options are less common than they were in years past, but some companies still offer them. With this type of compensation, no tax is due at the vesting date, but the stock must be held for at least one year to transfer it from ordinary income to long-term capital gains. But even if the individual is able to avoid ordinary income taxes, the stock options may be subject to the Alternative Minimum Tax (AMT), so there may be the need for intricate planning around these kinds of options.

In conjunction, a potential tool to use with your equity compensation would be your company’s deferred compensation plan. A deferred compensation plan is different from a 401(k), but the two should be working in tandem to help executives maximize the pretax value of whatever type of equity compensation they are granted.

What we’ve discussed here just touches the surface of what goes into planning for executives with equity compensation plans, but it does serve to illustrate how complicated the subject can be. For advisors working with clients in this situation I suggest that they draw up two plans — one with the equity compensation and one without — before deciding how and when to execute them. A client who has enough of a nest egg to be financially comfortable for the rest of their life (I suggest modeling out to age 100) can wait for the best moment to cash out, while someone who needs the money in order to retire or do whatever they want with their lives might need to pull the trigger sooner.

Ultimately, the goal of anyone fortunate enough to be granted equity compensation is to exercise their options in a way that maximizes the price, while also deferring and minimizing taxes to as great a degree as possible. That’s one of the areas where advice from a knowledgeable financial planner can make a tremendous difference in the outcome.


Kenneth Van Leeuwen is managing director of Van Leeuwen & Co., a wealth management firm he founded in Princeton, New Jersey, in 1997.