What to do with an executive compensation plan considering market volatility today
By Kelly Pedersen, CFP®
With all the market volatility today, the “roller coaster ride” we are experiencing can be unnerving for any investor. For corporate leaders with executive compensation plans that are closely tied to the gyrations of a chronically unsettled stock market, it can be particularly vexing.
As tempting as it may feel, the current environment of market volatility today is not the time to “stick your head in the sand” and just hope and pray for it all to end. Rather, volatile markets can be an ideal time for executives to work with their financial advisors to explore areas where they can lean into opportunity. Now, that doesn’t mean you should make decisions based on emotions alone, but rather to thoughtfully and strategically seize the opportunities that inevitably arise when markets are down or choppy. Below are some examples of ways that executives can manage market volatility:
Re-evaluate your executive compensation plan
If your company offers an employee stock purchase plan (ESPP) and the stock price is depressed (but you still believe in its long-term potential), consider accelerating your purchasing of company stock to buy in when the price is low.
For those with stock options, know that the option to buy company stock at a specific price and subsequently liquidate it (whether immediately or further out) is particularly susceptible to market volatility – which can present opportunity, too. When you exercise a non-qualified stock option, you must purchase the shares at the strike price (either with cash, or you can sell some shares to do a cashless exercise). At that point in time, you will generate taxable income equal to the difference of what you paid and what the market price of the stock is. So, if you exercise on a large drop in the market, you will likely have less taxable income on your return that year. If the stock pops up again, those additional gains could be taxed at a much lower capital gains rate if you held the shares for at least a year.
Other things to consider are whether your options are “non-qualified” or “incentive,” as they have very different tax rules. In the case of incentive stock options, make sure to understand how they are subject to alternative minimum tax (AMT) so that you don’t get an unwelcome surprise at tax time. Also be aware that tax withholding from many of these executive compensation plans are ballpark numbers based on a schedule. The calculation does not know what your actual tax bracket is, and therefore you could end the year under withheld and need liquidity to pay the taxes owed.
When it comes to the vesting and redemption of restricted stock units (RSUs), which is reported as compensation on your W-2 form, it’s important to understand that the approximate amount of tax owed on that compensation is withheld in the form of shares. The residual of the shares is yours to keep or sell. If you sell, be aware that you will owe capital gains taxes on the gain after vesting. With markets volatile like they are now, you could consider selling immediately at vesting and potentially owe very little, if anything, in capital gains taxes. This can provide you liquidity to diversify out of that stock position. You could also consider holding the position for a year, and then the capital gains tax would convert to long-term rates instead of short-term rates (which is equivalent to your ordinary income tax bracket).
Finally, remember that executive compensation, particularly company stock incentives, is meant to be a long-term incentive agreement between an employee and employer. For shorter-term liquidity, rely on your regular wages and budget / invest accordingly. By doing so, you won’t force yourself into an equity liquidity event that is unplanned.
Make the most of your 401(k) plan
Particularly when markets are depressed, maximize your employer match in a 401(k) plan. Also, accelerate your 401(k) contributions toward the beginning of the year to potentially take advantage of lower equity values. However, make sure you don’t contribute too aggressively to your 401(k) plan or you could run the risk of not receiving 100% of your employer match.
Depending on whether your company provides a “safe harbor” 401(k) match and if you are considered a high earner, you may be limited as to how much you can contribute to a 401(k) plan, which also impacts an employer match as well. Should this be the case, some companies offer a “spillover” plan that allows executives to maximize their 401(k) contributions and fully access the employer match in a separate plan offering. Working with your advisor, investigate if this is an option for you.
A volatile market can also be an opportune time to rebalance or reallocate the equity portion of your 401(k). Work with your advisors to shift your investments to take advantage of depressed values.
And did you know that many 401(k) plans offer “in-service distributions,” which if you meet the criteria (still employed at age 59½) allow you to move funds from your 401(k) to a personal IRA, with no tax implications or penalties? Doing so can potentially greatly diversify your investment options.