For most corporate executives considering retiring soon, there is plenty of financial planning to do before they call it quits. This advice may sound odd since executives are well-paid and most are feeling flush: A rising stock market over the past decade and a strong economy means they are better off now than ever.
One issue that an executive’s estate plan needs to address is the concentration of their wealth tied to their employer. Successful executives receive stock options and restricted stock grants as well as participate in retirement plans, such as 401(k)s and deferred compensation plans, all of which can contribute toward a concentration in company stock.
An executive accumulates all of this wealth over several years, and a typical personal balance sheet might look like the following:
- 35% company stock
- 25% insurance
- 15% real estate
- 15% non-qualified deferred compensation
- 10% in a 401(k) retirement plan
As retirement nears, most will need to diversify their portfolio because doing so will not only help protect their wealth but can help align with their estate plan to maximize the amount of money their heirs will receive.
Look at what happened in January 2022 to see the impact of owning too much stock in one company. With inflation continuing to rise and the Federal Reserve forecasting multiple interest rate hikes this year, many companies saw their stock prices fall by 10% or more. A person who retired at the end of 2021 with much of their wealth invested in their company’s stock could have experienced a significant decline in their net worth in just 30 days.
As retirement begins, stock options and restricted stock will likely continue to pay out, and group life insurance may end. The strategy shifts from accumulating wealth to prudently spending down wealth in retirement.
To protect your wealth while maximizing the amount of money your loved ones will inherit, here are five changes to consider as you approach or enter retirement:
Find a New Home for Your 401(k)s
Upon retirement, consider rolling funds from your company 401(k) plan into an individual retirement account (IRA). An IRA provides more investment choices, enabling an executive to better diversify their portfolio. An IRA may also offer lower fees.
Think Ahead about Taxes on Your Non-Qualified Retirement Plans
Many high-income executives choose to defer some of their income to non-qualified retirement plans, which are an additional way to save for retirement. Similar to a qualified 401(k) plan, pre-tax contributions are made to the plan and grow tax-deferred until a point in the future, often retirement, where the distributions are taxable to the employee. Non-qualified plans can include deferred compensation and supplemental 401(k)plans and these plans can vary in several ways, such as how and when account balances are paid out.
For example, if a person has saved $1 million in a deferred compensation plan, company policy may call for it to pay out over 10 years during retirement. However, upon death, it will likely pay out immediately in a lump sum, making the balance subject to higher taxes because income will likely be pushed into higher tax brackets. So, an heir who inherits $1 million could easily be forced to pay 40% of the proceeds in federal and state income taxes.
Any executive who expects to receive deferred compensation during retirement needs to understand the specific rules of their company’s plan under such circumstances.
Understand Your Stock Options and Restricted Stock
Most executives understand they will pay income or a capital gains tax once they exercise stock options. But when it comes to estate planning, many don’t know how options are treated at death.
Each company has its own policy, but many give an executive’s heirs up to one year after death to exercise the stock options. After one year, unexercised options expire and are worthless. However, because options are granted at various times during an executive’s career, some may expire earlier than that. Again, it is imperative that an executive understand the specific rules governing their stock option plan in the case of death.
Restricted stock is a bit different in that, unlike a stock option, the employee does not need to take action to receive the shares. However, similar to options, the death of the grant owner can trigger a different vesting schedule. This means that heirs may receive shares of company stock at a different time than originally anticipated and taxes will be due.
While income taxes are typically withheld from the stock option or grant proceeds, be careful; when your company or former employer withholds the taxes, they may not take out enough money to fully cover the associated tax.
Consider Dropping Your Group Life Insurance
In their working years, many executives find that their company-provided group life insurance is not enough. And, even if it is sufficient, it may make more sense to buy a private policy that provides additional coverage – and often at a lower cost.
In retirement there should, theoretically, be no need for life insurance for purposes of replacing a lost income due to death. Consequently, there is often a cost savings available by dropping excess life insurance coverage that is no longer needed. For purposes other than replacing a lost income, there may still be a need for life insurance. However, retirement may be a good time to review whether a different type of life insurance policy may be better suited for the situation.
In retirement, a more appropriate and typical personal balance sheet that reduces concentration in company stock might look like the following:
- 30% diversified taxable portfolio
- 30% real estate
- 25% IRA
- 10% company stock
- 5% life insurance
Making these simple changes will help achieve two goals – protecting your wealth while also aligning your estate plan so heirs can receive the maximum amount.
Diversifying away from company stock moves your money away from a company where you’ve worked for decades and can be a little unnerving. After all, most executives who owe their wealth to one employer feel a sense of loyalty – even ownership – in that company. But once you leave, the company will likely change. Instead, look toward the future to make the most of your hard-earned money.
Wealth Adviser, Brightworth LLC
Bud Boland is a Wealth Adviser at Brightworth and has devoted his career to working with high net worth and high-income individuals and families. Bud works closely with clients to understand their needs and develop customized financial plans to help them reach their short- and long-term goals. Bud is a CERTIFIED FINANCIAL PLANNER™ practitioner and received his Bachelor of Science in Financial Management with an emphasis in Financial Services from Clemson University.