retirement planning

Planning to Retire in 3 Years? Here’s What Senior Level Executives Need to Do Now

From deferred compensation and stock options to backdoor Roths and long-term care insurance, there’s a lot to think about before you get your gold watch.

One of my new clients plans to retire in three years following a successful 30-year career in Corporate America. Like many executives who have spent a lifetime at one employer, most of her income — salary, bonuses, stock options and other deferred compensation — is tied to the company’s success.

To protect her fortune, she will need to take a few key steps to maximize her wealth in preparation for a retirement.  If you are planning to retire soon, here are four actions you can take now to be prepared:

Begin to Diversify Your Wealth

Most senior-level corporate executives have received company stock grants and equity options over the years.  For this particular client, company stock makes up approximately 30% of her investments.

Even if you work for a successful company, it is inherently risky to have too much wealth tied up in any single company stock. The pandemic quickly jolted the stock prices of many sectors, including airlines and hospitality companies. An executive with company stock valued at $1 million today wouldn’t want to see that number reduced by 20% to 30%, no matter the reason.

One strategy to help mitigate this risk is to sell your company stock as soon as shares vest. This move will reduce your exposure to company stock and the likelihood of paying additional capital gains taxes from holding the stock for a period of time and then selling later.

For example, consider a Restricted Stock Unit (RSU) grant of 100 shares of company stock that vests three years after the grant. On the three-year anniversary of the grant when the RSU vests, you will report ordinary income for the value of the 100 shares, based on the stock price on the vesting date.

Generally, a portion of the 100 shares is withheld for taxes and you may receive approximately 75 shares as a result.  Upon receiving the 75 net shares, your cost basis for the shares is equal to the fair market value of the 75 shares. In other words, you have zero capital gain or loss.

If you decide to hold the 75 shares for a few months after vesting and then sell at a higher stock price, you’ll have a short-term capital gain on the growth, which results in additional taxes. To avoid the additional taxes and reduce your allocation to company stock, it can be a good strategy to sell the shares immediately upon vesting, and then reinvest the proceeds into a diversified portfolio.  Doing this each year that your RSU awards vest will help reduce your risk of overexposure to company stock.

Understand How to Manage Deferred Compensation

Many executives have built a substantial balance in deferred compensation plans that will serve as a key source of income in retirement. Unfortunately, many executives lack a cohesive strategy when choosing their payout elections.

Most deferred compensation plans give executives a choice of a lump sum payment or annual payouts over a period of years. This choice will have a significant impact on income and taxes paid once an executive retires. Depending on your retirement age, choosing five- or 10-year distributions could provide steady annual income to bridge the gap between retirement and income from Social Security benefits, or required minimum distributions from a retirement account at age 72.

For example, someone who would collect $750,000 in deferred compensation at retirement would likely pay 37% percent or more in federal taxes if they decide to take a lump sum payment. However, if they choose to spread the payments out over several years, that income becomes part of their overall annual income. The tax bill will potentially be much less, and investment growth in the deferred compensation plan can help increase future income over time.

Most companies allow executives to elect annually how their deferred compensation will be paid after retirement. For an executive earning $350,000 annually, deferring 20% of their salary into the 2021 compensation pool means deferring $70,000. By choosing to defer this amount for each of the next three years, they can receive the money, plus any investment growth, over a five- to 10-year period at retirement.

Open an Individual Retirement Account (IRA) or Roth IRA for your spouse

My client’s spouse has not been working for several years and does not have an IRA or Roth IRA.

A working spouse is eligible to contribute to an IRA or Roth IRA in the name of a non-working spouse with no or little income. For 2021, the use of a spousal IRA strategy allows couples who are married filing jointly to contribute $12,000 to IRAs per year — or $14,000 if they are age 50 or older, due to the catch-up contribution provision.

It is important to consider income limits when determining eligibility to make tax-deductible IRA contributions, non-deductible IRA contributions, or direct after-tax Roth IRA contributions.  Depending on household income and tax rates, you may be limited to certain options. 

For example, my client’s household income exceeds the limit to make a tax-deductible IRA contribution. They are also phased out of contributing directly into a Roth IRA.  There is no income limit, however, for making non-deductible IRA contributions, which is what they will do.

The non-working spouse will open both a traditional IRA and Roth IRA in order to ultimately make what is called a “backdoor” Roth IRA contribution.  This is done by making a non-deductible contribution to the traditional IRA, and then converting the funds to a Roth IRA shortly after.  Since the IRA contribution is not tax-deductible, the conversion is tax-free.  The end result is effectively the same as making a direct Roth IRA contribution.

There are several caveats to this strategy, so consult a tax adviser before making any decisions. For one, a person with existing IRAs funded with pretax contributions will owe taxes when converting IRA money to a Roth IRA.  

Consider Purchasing Long-Term Care Insurance

Corporate executives typically enjoy a wide variety of insurance plans from their employer, including health, disability and life insurance. While you will qualify for Medicare at age 65 and likely won’t need life insurance, it’s a good time to consider buying long-term care insurance.

These policies typically pay for in-home aides, nursing homes and other costs for people who can no longer care for themselves.

Assuming you are in good health and eligible for coverage, many experts say the optimal age to purchase this insurance is between ages 60 and 65. You are neither too young nor too old, making monthly premiums affordable.

Long-term care insurance is not the right choice for everyone. Some people decide to self-insure, deciding to invest money for the next 10-20 years rather than pay insurance premiums over that period. And, of course, it’s possible the insurance may not be needed. But now is the time to investigate if it’s right for you.

With solid planning, most executives can position themselves now to reap the maximum benefits from their compensation once they decide to call it quits. For many, it could mean adding hundreds of thousands of dollars to their portfolio while also cutting their taxes for years to come.

About the Author

Ryan Halpern, CPA, CFP®

Wealth Adviser, Brightworth

Ryan Halpern is a partner and adviser at Brightworth, an Atlanta-based investment company that provides custom wealth management solutions to individuals, families and corporations. He advises corporate professionals and executives on their personal finances and investments. He is a CPA, CERTIFIED FINANCIAL PLANNER™ practitioner, Personal Financial Specialist and has earned the CFA Institute Investment Foundations™ Certificate. He lives in Atlanta with his wife, Stacey, and daughter, Hayden.

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