By Kevin Boutwell, CFP®
There’s a reason your employer offers you a benefits package: it’s an incentive for you to stay with the company and a reward for your hard work and loyalty. Additionally, if your employer can align your financial well-being with that of the company, it’s a win-win for everyone. One way employers do this is by providing equity compensation in addition to base salary.
But receiving equity compensation is only the first step. To fully maximize this benefit, you need to properly incorporate it into your overall financial plan. Our team at Veracity Capital has experience with equity compensation models and can help guide you through the process. Consider these five tips on how to get started.
How to Build Your Financial Plan With Equity Comp in Mind
In practice, we’ve found that there are two main ways you can take advantage of equity compensation: cash flow planning and investment planning. Both options have several specific actions you can take to better utilize your equity benefits.
Cash Flow Planning
Cash flow planning involves budgeting and tracking income and expenses so you can better allocate your resources toward savings and other financial goals. For those who receive equity compensation, cash flow planning is key to incorporating your benefits into your overall financial plan.
1. Fund Cash Flow Deficits
Over the years, total compensation packages have skewed more and more to the equity side, and less to high base salaries. This can create problems for many clients because as salaries remain the same, housing costs, childcare costs, and the cost of daily goods and services continue to rise, leaving many clients to rely on their restricted stock vesting and/or bonuses to fill in the gaps.
If this sounds like you, consider creating a budget to help identify the monthly or annual shortage between your base salary and your non-discretionary expenses. Once this has been done, you can sell the number of company shares required to cover your shortfall.
It’s important to map this out prior to when you actually need the funds, so you can be sure your actions are tax-efficient. Accurately valuing your stock options or RSUs is also crucial. The last thing you want to do is sell thinking you’ll receive a certain amount, only to learn that your net earnings are much lower. This can be especially harmful if the purpose of the sale is to fund everyday living expenses.
2. Finance Future Goals
On the other hand, if you do not need to sell the shares to fund your monthly cash flow, you can instead allocate them toward future goals, like large one-time purchases, home renovations, vacations, retirement savings, or education funding. Because it can be difficult to know which goal should take priority, be sure to talk to your advisor about how to plan for multiple goals.
Once you’ve decided on a goal, it can be funded by selling the underlying stocks associated with employee stock purchase plans (ESPPs), employee stock options (ESOs), or vested restricted stock units (RSUs).
All these options should be well planned out since holding the stock for at least a year before selling will result in favorable tax treatment. It is crucial to incorporate equity compensation into your financial plan sooner rather than later. The tax consequences for these plans are usually years in the making, so you’ll want to plan far in advance to reduce your liability and maximize your benefits.
While the cash flow planning strategy focuses on selling stock for funds that can be invested, the investment planning strategy focuses on staying invested in your company stock and how that can be used to maximize your future financial goals.
3. Assess Your Company’s Performance
The first step you should take when incorporating equity compensation into your financial plan is to evaluate your company’s stock objectively. How is it performing relative to the entire industry’s performance? How is the industry performing relative to the market?
It’s easy to get swept up in rooting for the home team; after all, they are the ones who pay you. But would you buy your company’s stock if you didn’t work there? If the answer is no, then you probably don’t want to hold on to the stock for much longer than you have to.
4. Buy and Hold
If you evaluated your company’s performance and decided that, yes, you would buy the stock even if you didn’t work there, then consider using a buy-and-hold strategy. Not only will this give you the potential for growth, it will also help you minimize tax liability by allowing any gains to be considered long-term. Keep in mind that this strategy should be periodically reevaluated to ensure it continues to make sense in your overall plan. It should not be a set-it-and-forget-it mentality, especially if it leads to an undiversified investment portfolio.
5. Consider Diversification
On the topic of diversification, it’s important to assess your overall risk level when you own significant amounts of company stock. If it makes up more than 10% of your total investable assets, you are in a highly concentrated stock position. This is great if your company stock does nothing but grow for the next 20+ years, but the reality is that most stocks have dramatic ups and downs that can wreak havoc on a financial plan.
In order to mitigate the downside risk associated with concentrated stock positions, consider the following options to diversify your portfolio:
- Exchange funds: A pool of stock shares from different companies; each investor contributes shares of a single company’s stock in exchange for shares of the diversified pool.
- Variable prepaid forward: A sale agreement where the investor agrees to sell their concentrated stock position in the future in exchange for a cash advance up front.
- Equity collars: These are created by selling a call option and using the funds to purchase a put option, which acts as a hedge against downside risk.
Have More Equity Compensation Questions?
It’s understandable to feel overwhelmed with your equity compensation options. But with the proper management, it can be an incredible benefit to your finances. At Veracity Capital, we specialize in helping clients maximize their opportunities and minimize the headaches associated with complicated equity compensation packages. We work to help our clients have a clear understanding of their equity compensation and how it fits into their broader financial picture. If you’re interested in learning more about how I serve my clients, I encourage you to contact me today for a no-obligation get-acquainted meeting. Reach out to me at 678.888.4952 or firstname.lastname@example.org to get started.
Kevin Boutwell is a wealth advisor and partner at Veracity Capital. With almost a decade of experience in the financial industry, Kevin has acquired expertise in managing equity compensation. He focuses his services on corporate executives who have complicated compensation packages and resulting tax headaches. He believes that proper financial planning drives the best investment decisions, and his customized process and strategies help his clients achieve better outcomes. Kevin prioritizes building long-term relationships and offers the perfect mix of analytical, problem-solving, and a personal touch so his clients can focus on what’s important while knowing their finances are taken care of.
Kevin is a highly decorated veteran former U.S. Navy pilot. He got his start in the financial industry at Goldman Sachs and is a CERTIFIED FINANCIAL PLANNER™. Kevin earned his Bachelor of Science in Mechanical Engineering from the Georgia Institute of Technology and an MBA from Indiana University’s Kelley School of Business. Out of the office, you can find Kevin staying busy with his family, including his young triplet sons. He stays involved with several non-profit veteran organizations and participates in the Georgia Tech mentoring program. When he has a spare moment, he enjoys staying active with CrossFit and an occasional round of golf. To learn more about Kevin, connect with him on LinkedIn.
Advisory services offered through Veracity Capital, LLC, a registered investment advisor. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial advisor and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.