Executive Compensation Explained
Jordan Edwards | September 15, 2019
As Seattle has evolved into one of the largest tech hubs in the country, the clients we serve increasingly have very complex financial situations. This is partly because tech employees tend to be more highly compensated than people in other industries, but it is also due to the fact that tech companies tend to offer more complex compensation benefits than just salary to their employees. Between things like 401(k), stock grants, stock options, deferred compensation plans, ESPP, (among other benefits) it can be difficult to know how much in total compensation you could earn at one company compared to another – much less knowing how best to prioritize those options. I will briefly describe each of these options and how they work, but if you would like professional guidance on how best to leverage your benefits, please click below:
The most well-understood workplace benefit is usually the 401(k). Most large companies have been offering 401(k) benefits to their employees for many years now. In 2019, an employee with a 401(k) plan can defer up to $19,000 from their income into an account in which they can invest. This reduces their taxable income dollar-for-dollar and the funds in the 401(k) can grow tax-deferred. Many companies match 3% or more of their employees’ contributions, so oftentimes if you aren’t participating in your company 401(k) plan you are giving away free money!
A less well-known 401(k) plan option is the Mega Backdoor Roth Conversion benefit. Many company 401(k) plans still do not offer this option, but for those that do it can be an extremely powerful tool. This allows potentially tens of thousands of dollars per year to be contributed to a 401(k) plan on an after-tax basis and converted to Roth where all growth is tax free and distributions in retirement are also tax free!
Also known as restricted stock units (RSUs), stock grants are a compensation benefit given to many executives in the tech community. Amazon, Microsoft, Google, and many others choose to offer these grants to incentivize their executives to make decisions that will benefit the long-term growth to company shareholders. These shares are “restricted” because they cannot all be sold immediately upon being granted. Instead, these shares vest over time – oftentimes over the course of several years. As they vest, they become taxable income and typically some of the shares are sold and the proceeds sent to the IRS for taxes. For many tech employees, deciding what to do once the taxes have been paid and the shares are vested in a brokerage account is very difficult. Please read this recent article written by my colleague, JP Osseward, if you are interested in learning more about what to do with company stock awards.
Fewer companies are offering stock options these days and instead are choosing to offer equity compensation through RSUs, although plenty of companies still do offer stock options. Stock options give employees the right (but not the obligation) to purchase shares of company stock at the grant price rather than the current market price. For example, a person may have been granted the option to purchase 1000 shares of company stock for $1 per share four years ago. If the stock price today is $10 / share and the options vested (are available for sale) after 4 years, this person could purchase 1000 shares for $1,000 even though the shares are worth $10,000. Most of the time, there is an option to have all the shares sold at the same time and simply have the $9,000 of stock growth paid out as cash. There are important tax implications to consider with stock options, so consult a professional before making trades.
Deferred compensations plans beyond the traditional 401(k) vary widely, but can be incredibly powerful tools for highly paid executives who find themselves in the top tax brackets each year. Please reach out to us to help you evaluate your deferred compensation plan because while some plans offer very little benefit, some function like a 401(k) on steroids! For example, at Microsoft once you reach a job title at level 67 or higher, you have access to a plan that can save you an incredible amount of money each year in taxes. Click here to view a video I have previously done on the benefits of the Microsoft Deferred Compensation Plan (DCP)
An Employee Stock Purchase Plan (ESPP) is another way companies offer stock compensation to employees, but these plans vary a lot. What typically happens is that you defer income into an escrow-type account for some period (a month, quarter, 6 months. etc.) and at the end of the period, the funds are used to purchase shares of company stock at a discount. As I’ve previously written, some ESPP plans can be a no-brainer. These plans virtually guarantee a nice return on investment if the shares are sold the same day they are purchased at a discount. However, because these plans vary so widely, make sure you understand exactly how the share price “discount” works with your plan before participating.
If you would like help leveraging your company benefits in order to grow your wealth most efficiently, please reach out to us: