Year-end planning tips for corporate executives

The end of the year is a busy time for corporate executives for several reasons, not the least of which is the need to finalize financial decisions that could have a substantial impact on personal wealth. For corporate executives, who may have multilayered compensation packages, there are several issues to consider before choosing how to ring in the new year.

Dean Deutz, vice president and private wealth consultant with RBC Wealth Management in Minneapolis, says it’s a common misconception that people with a business résumé necessarily have a comprehensive knowledge of their own finances; it can also be natural to focus on work at the expense of paying attention to one’s own needs.

“What they’re really good at is running their business, and that doesn’t mean that they understand their stock compensation plans or the tax laws that go along with them,” says Deutz. Stock incentives, for instance, can come in different forms that vary in how they impact income.

With these decisions having a significant impact on long-term wealth preservation, executives need to have a solid year-end plan that considers both short and long-term goals, and maximizes the potential benefits of their compensation packages.

Consider deferring income

Many compensation plans include the ability to defer a portion of salary or bonuses for a pre-determined number of years. This can be a handy tool both for retirement planning and for evening out annual income from year to year. Deferring allows the income to accumulate tax-free, with taxes paid only when it is eventually distributed.

“If they’re in a high-income tax bracket, then it may make sense to defer some of that income to future years,” says Deutz.

The amount that can be deferred and the potential deferral period can vary based on income level and the plan. Under a 401k deferral, for instance, an executive nearing retirement may be able to spread the deferred income over as much as 10 years after retiring.

Nuri Benturk, senior vice president of corporate & executive services at RBC Wealth Management in New York, says deferring is an underused tool, and one that many executives may not be aware they qualify for.

“I’m not talking about CEOs and CFOs who may have special packages and all the bells and whistles, but the standard executive who maybe gets a certain amount of options, or a decent bonus, may or may not need the additional income that year,” he says.

On a deferred income decision, RBC advisors work closely with a client’s certified public accountant to coordinate wealth planning needs with the client’s current tax situation.

Benturk says an important consideration for someone thinking of deferring is once the decision is made, the deferred income ceases to be income, but instead is considered part of a contractual agreement between the company and employee. This means in the event of a bankruptcy, the employee would become an unsecured creditor of the company, which could potentially make recouping the funds difficult.

“If you are comfortable with the company, I would take the chance,” he says.

Know your (stock) options

Stock options can be a lucrative component of a corporate executive’s compensation package, particularly in a strong market. But different types of options need to be approached in their own way, and not simply filed to the back of mind to be sold on a rainy day.

The typical employee stock option allows an employee to buy a certain amount of stock at a certain price following a vesting period. So if a stock option is awarded when the share price is $10, and it rises to $15 during the vesting period, the employee has the option to buy the stock at the $10 price, and then hold it or sell it at $15.

Restricted stock units on the other hand, are issued with a vesting day set out in the future. Unlike stock options, restricted stock units don’t require the employee to pay for the units. Once the units have vested, the employee can keep the stock or sell.

The difference between the two is when you must claim the value as income. With restricted stock units, it’s when the units vest. For stock options, the income is claimed when the stock is sold, which gives the employee the ability to decide which year to take it. Executives receiving options should be aware of how they impact income from year-to-year, and factor that in to other decisions, such as whether to defer salary.

One issue that can be particularly significant for executives is the challenge of making trading decisions on shares in their own company while being considered an insider, or someone in a key decision-making position. While insiders can trade their shares, they are subject to blackout periods around corporate earnings or other significant dates.

“The windows can open for a short period and close again. It’s a little bit of an inconvenience for the executive, especially if they have something timely to finance, like a purchase, a wedding, hospital bills,” says Benturk.

Investors subject to these blackouts may want to consider a “Rule 10b5-1″ plan, which allows an executive to set up a pre-determined trading schedule that is then executed by an investment manager. This would allow, for instance, a plan to make regular stock sales on a certain date each month. Blackout periods would not apply, since the investor is not actively making decisions.

Spending down an annual FSA

Executives with health plans that include a Flexible Spending Account (FSA) may need to make some quick decisions on medical spending as the year winds down, as the plan allows only a small amount to be carried over to the following year.

While it may not be difficult to come up with ideas to spend the money, the trick may be to book appointments during the final weeks of the year, when other FSA users are doing the same thing.

“A lot of people in December are thinking the same thing,” says Deutz.

Reading the harvest

Another end-of-year decision that can end up saving money is harvesting losses. This may mean selling investments that have had a rough year, and using the loss to offset gains in other investments, or otherwise reduce overall income. The money can then be reinvested elsewhere, putting it back to work in the portfolio.

There are limits on how this can be done, however, and the “wash-sale” rule prevents selling one investment to harvest a loss and then immediately buying another identical asset.

“It works better if you have individual stocks (rather than funds),” says Benturk. “It’s a very simple thing, but people forget about it.”

But both Deutz and Benturk say a common misstep for corporate executives is to get bogged down in the year-to-year income ebb and flow, and forget that long-term wealth preservation is the ultimate goal.

“There’s an old saying: ‘Don’t let the tax tail wag the investment dog’,” says Deutz. “You want to make sure that you look at your investments first.”

This also means not getting caught up in anticipating changes to tax or investment law, he says. “You don’t know what it’s going to look like until it’s actually passed and signed into law. So it’s a little dangerous to try and make decisions based on proposals.”