No matter where you are at in your career, thinking and planning for retirement should be top-of-mind. For employees with equity compensation packages, you may have already reached your retirement goals if you include the value of your package. On the other hand, you may need to take a deeper look into your finances before you make the jump into retirement.
Equity Compensation Explained
Equity compensation is any compensation that is based on the value of specified stock (generally, the stock of the employer). It usually imposes a vesting period, which encourages you to remain with the company for a certain time to receive the benefit. This is particularly true as equity compensation might be accompanied by a below-market salary.
However, equity compensation is not just of value to the employer wishing to retain outstanding talent. It can also be central to the retirement plan of those same employees. If you picked the right company — one whose stock price grows substantially during your tenure there — the value can be a critical component of your retirement plan.
From just $107.88 $24.99 for Kiplinger Personal Finance
Be a smarter, better informed investor.
Sign up for Kiplinger’s Free Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
Using Equity Compensation for Retirement Planning
More than half of employees receiving equity compensation expect to use it as part of their retirement. According to Plan Adviser, the average vested balance is over $97,000 and the average total value for a worker’s equity compensation is almost $150,000. However, to use the shares for early retirement, you need to be sure that you have met all of the requirements for vesting these shares.
Current evidence indicates that fewer than one-fourth of employees have ever exercised their stock options, according to CNBC. If you do plan to exercise your options and use your equity compensation in retirement, you might have to satisfy certain conditions, including an age-at-retirement requirement and a length-of-service requirement. However, it is important to note that, even if you meet these requirements at the time you decide to retire, it is possible that under a company plan you still may not be entitled to receive any of your unvested shares.
Instead, such shares could be forfeited, continue vesting on the original schedule, or, in some cases, may vest immediately. Be sure you understand exactly how your plan works. A financial professional can give you useful guidance here as well.
Holding on to the Shares – or Not
One of the most basic rules of an investment portfolio is that diversification is perhaps the primary risk control. A diversified portfolio may protect those who do not spend their full time watching their stocks; as Warren Buffett said, "Diversification is protection against ignorance" for the non-professional investor.
A danger that using equity compensation presents in retirement is that, by its very nature, it is not diversified. In other words, as you get older, by relying on your equity compensation portfolio and company stock, you could be overexposed to risk in the stock of one individual company — your employer — in a manner that no longer fits your investment profile.
Even when you recognize this risk, managing it can be difficult. There are several ways to approach this problem. If you have received more than one type of equity compensation, you may be able to use them strategically to assist in diversifying your risk. On the other hand, if you have a financial or emotional reason to continue to hold the concentrated position, you may want to be aware of what this will mean for your retirement fund. You should determine if you are dependent on this money or if it is extra.
Similarly, it is also possible to hold the concentrated position or sell it into the market. In any case, you should realize that a concentrated portfolio may be more volatile than a diversified one, which may present more risk than the soon-to-be-retired you wishes to carry.
Once you decide how much of the equity compensation you want to continue to hold, an investment professional can guide you toward a variety of investment strategies. One example may allow diversified assets to produce income to cover your “early” retirement years without touching tax-qualified assets that might incur penalties or taxes. You should also consider your continuing involvement with your company, which will affect how quickly and how much you wish to sell.
Planning for Taxes
If you decide to reduce or liquidate the equity compensation position, it is also important to remember that liquidating those shares may very likely create tax consequences for you. There can be both ordinary income and capital gains taxes on the shares, and the timing and payment of these taxes need to be planned for as well. Failure to do so can have a significant adverse effect upon your retirement assets. Retirement income is taxed in several different ways, and planning for that is essential.
You will need to plan the timing of your liquidations to spread out the tax consequences, as well as your retirement cash flow. You should work with your financial professional to explore ways to generate income from the shares you continue to hold. They can also help you with planning to cover taxes that will arise from investment income, sales of shares and, eventually, from withdrawals from your retirement accounts.
Early Retirement
Equity compensation can give you an important bridge from early retirement to the age when your other retirement assets become available. Using those shares to produce income over the years of early retirement will make possible the later, penalty-free use of traditional retirement assets.
Advisory services offered through Capital Analysts or Lincoln Investment, Registered Investments Advisers, Securities offered through Lincoln Investment, Broker/Dealer, Member FINRA/SIPC. www.lincolninvestment.com. SimoneZajac Wealth Management Group, LLC and the above firms are independent and non-affiliated.
Diversification does not guarantee a profit or protect against a loss. This article contains links to third-party websites. We make no representation as to the completeness or accuracy of information provided at these sites. Nor are we liable for any information you receive arising out of your access to or use of these third-party sites. When you access one of these sites, you assume total responsibility for your use of the sites you are visiting.
Advisory services offered through Capital Analysts or Lincoln Investment, Registered Investments Advisers, Sercurities offered through Lincoln Investment, Broker/Dealer, Member FINRA/SIPC. www.lincolninvestment.com. SimoneZajac Wealth Management Group, LLC and the above firms are independent and non-affiliated.
-
Dave Ramsey Tells Us the Biggest Retirement Mistake You Can MakeThe talk-show host, author and podcaster tells Kiplinger what people can do to ensure a happy retirement.
-
Pros and Cons of Alternative Assets in Workplace Retirement PlansWhile alternatives offer diversification and higher potential returns, including them in your workplace retirement plan would require careful consideration.
-
I'm a Wealth Adviser: These Are the Pros and Cons of Alternative Investments in Workplace Retirement Accounts
While alternatives offer diversification and higher potential returns, including them in your workplace retirement plan would require careful consideration.
-
I'm a Financial Planner: If You're Within 10 Years of Retiring, Do This TodayDon't want to run out of money in retirement? You need a retirement plan that accounts for income, market risk, taxes and more. Don't regret putting it off.
-
Five Keys to Retirement Happiness That Have Nothing to Do With MoneyConsider how your housing needs will change, what you'll do with your time, maintaining social connections and keeping mentally and physically fit.
-
Budget Hacks Won't Cut It: These Five Strategies From a Financial Planner Can Help Build Significant WealthCutting out your daily latte might make you feel virtuous, but tracking pennies won't pay off. Here are some strategies that can actually build wealth.
-
To Unwrap a Budget-Friendly Holiday, Consider These Smart Moves From a Financial ProfessionalYou can avoid a 'holiday hangover' of debt by setting a realistic budget, making a detailed list, considering alternative gifts, starting to save now and more.
-
Treat Home Equity Like Other Investments in Your Retirement Plan: Look at Its Track RecordHomeowners who are considering using home equity in their retirement plan can analyze it like they do their other investments. Here's how.
-
Why Does It Take Insurers So Darn Long to Pay Claims? An Insurance Expert ExplainsThe process of verification, investigation and cost assessment after a loss is complex and goes beyond simply cutting a check.
-
Two Reasons to Consider Deferred Compensation in the Wake of the OBBB, From a Financial PlannerDeferred compensation plans let you potentially lower your current taxes and help to keep you out of a higher tax bracket. It's important to consider the risks.
