All investors face an array of wealth management challenges and opportunities. But as detailed in a recently released report from Forbes Insights, “Thriving In, And Retiring From, The C-Suite: 5 Wealth And Investment Management Planning Insights For Senior Executives,” being a C-level executive introduces enormous complexity.
For example, corporate officers often are required to hold significant positions in their company’s securities, introducing concentration risk. Similarly, they face a range of ongoing decisions regarding deferred compensation and when to recognize the tax on stock grants and options.
It’s clear the C-suite faces unique challenges within wealth management. Here, Henry Johnson, Northern Trust’s east region president, wealth management, shares his views on five steps you can take to address them.
1. Unravel complex cash flow and net worth
Step one to better managing your wealth is no small feat as C-suite wealth and compensation can be complex. In general, “C-suite executives tend to receive total compensation well in excess of the average investor,” says Johnson. The challenge, however, “is that so much of that compensation is tied up in securities—stocks and stock options.” Relatively speaking, he says, “the C-suite tends to be asset-rich and cash-poor.”
Still, “when we look into their financial lives, we tend to find stores of cash and assets that are all over the place. They have so many sources, from salaries and bonuses to restricted stock grants, stock options and investment vehicles like employee stock ownership plans, 401(k)s and other brokerage accounts.”
Unraveling it all is a critical step in understanding their current financial position. Upon close inspection, “what we often find is that these executives largely underestimate their true wealth.” In particular, “they often take a static view, looking at what they have today instead of taking into account the power of compounding,” says Johnson.
Another common issue “is having multiple accounts holding similar assets across a range of providers.” This not only complicates ongoing analysis, but also means executives “are paying much more than needed in management fees and they could benefit from concentration.”
Finally, tax optimization is too often treated “as an afterthought,” says Johnson, but when net worth and earnings “are viewed holistically through a tax lens, performance can improve significantly.”
2. Optimize current vs. deferred compensation
C-suite executives are often given the option of deferring a portion of their earnings into corporate-owned, nonqualified savings plans. Here, “executives have to take into consideration how long they believe they’ll be serving and how much they’ll be earning in terms of a range of incentives.” In addition, “they need to consider tax rates, including state and local taxes from wherever they are going to be when the income is realized.” The prior step of “getting a good grip on where they are currently,” says Johnson, “is essential to making informed decisions about deferrals.”
Additionally, a common mistake in deferment planning—and wealth management planning in general—is that executives assume their earnings streams will end when they leave the C-suite. But in reality, says Johnson, “today we find executives like these working five, 10, 15 or more years as executive board members, consultants or in similarly well-compensated roles.”
3. Determine the 83(b) election
C-suite executives customarily receive significant compensation in the form of restricted stock—nontransferable shares in the business that vest over a specified period. A key challenge here is designating when tax will be realized, which is known as an 83(b) election within the Internal Revenue Code.
When it comes to this, executives have two options, says Johnson. “They can pay the tax when the shares are granted and that’s that.” Alternatively, an executive can elect to defer tax “but then pay based on the full market value when the shares vest.” This choice can be tricky, he says. “Over time, the shares can appreciate substantially, remain flat, or they can fall in value. You’re also exposed to market risk as your company could be performing just fine but its value falls in an overall declining market.”
Bottom line, says Johnson, “an 83(b) election is placing a bet on the company, on future tax rates, even on your own career as to whether or not you’ll still be there when the shares vest.”
4. Minimize concentration risk
C-suite executives are inescapably and deeply exposed to the fortunes of their employer. Not only do their salaries and bonuses stem from a single source, but as mentioned earlier, executives also often receive a great deal of stock and stock options.
Traditional means of diversification are often not possible, and more often than not these executives must meet minimum holding requirements stipulated by their employment terms. In turn, “their employers and the marketplace can clearly see these positions, so they can’t simply sell off,” says Johnson. “Both the rules and the perceptions matter—these executives are expected to have their fortunes tied to those of their employer.”
To address concentration, “we need to look at all the pieces of the portfolio that can be diversified, and to do so, we look for any unnecessary concentrations,” says Johnson. Additionally, “executives are often granted nonqualified stock options as part of their remuneration.” Carefully structured, says Johnson, these assets can be transferred to third parties, such as family members, and still appear to the public as if they remain under the control of the executive.
5. Engage 105(b) elections
Another tool for reducing concentration risk is determining how to “schedule” the future sale of the company’s stock using the 105(b) election. As Johnson explains, “anyone in the C-suite is a company insider, so there will be periods when they are deemed to have material, privileged information and so they can’t trade the company’s securities.”
Here “a 105(b) election allows the executive to schedule the sale of a predetermined number of shares on a set date in the future.” Such elections are typically set for between six months and two years but can be made only during “open periods” when the company indicates its executives have no material nonpublic information. Again, says Johnson, “this is an ongoing evaluation for the C-suite executive.”