Stock options, restricted stock grants, corporate-owned life insurance, retiree health insurance, deferred compensation packages, and defined-benefit pensions are all potential aspects of a CEO’s portfolio of retirement benefits. Most of the choices he or she makes when retiring are time-sensitive and irrevocable, so in the absence of a “mulligan,” they must be made carefully. In addition, the impact of estate and inheritance taxation and other forms of governmental wealth confiscation must not be overlooked.
All of the income generated from restricted stock units (RSUs), deferred compensation plans, and pensions will create taxable income. In most cases, the taxes applied will be at ordinary income tax rates and will not qualify for capital gains treatment. If all of these plans happen to pay out in the same calendar year, the income tax bill can be devastating—nearly half of all income can be lost to taxes between federal and state income taxes and the relatively new Medicare surcharge. To minimize the tax hit, consider some or all of the following strategies:
- Stagger the deferred compensation payments over a stretch of years to level out the income and the tax hit.
- Consider not starting deferred compensation payments until after all RSUs have vested and taxes have been paid.
- When exercising stock options, consider holding the underlying stock long enough to qualify for capital gains tax treatment on any growth.
- Own enough permanent life insurance in an irrevocable trust to accept a single life pension (without a survivor benefit to your spouse or other beneficiaries). This single-life pension will make sure you get the most possible benefit from the defined-benefit plan. Plus, if structured properly, the death benefit can be income tax free to beneficiaries and can replace the wealth lost to Uncle Sam.
- Prior to retiring, establish formal primary residency in one of the seven states in the U.S. which does not impose a state income tax, namely Alaska, Florida, Nevada, South Dakota, Texas, Washington or Wyoming.
- In the year of the maximum income being received, fund a charitable remainder unitrust (CRUT) to get the maximum charitable tax deduction and to turn a highly-taxed lump-sum payment into a potentially lower-taxed series of payments over a period of years or your remaining lifetime. Ideally, fund the CRUT with highly-appreciated company stock, as the charity can then sell the stock and avoid capital gains tax entirely. A wealth replacement trust funded by life insurance can replace the gifted property upon your death—estate and income tax-free.
- Consider hiring a team of advisors—a CPA, an estates and trusts attorney, and a certified financial planner practitioner to guide you through the many landmines in this process.
In summary, CEOs have an extraordinary opportunity to build wealth, but must carefully consult with a team of specialists when preparing for retirement. The right Certified Financial Planner will be able to assist in navigating an often complicated set of decisions, deadlines and tax rules, each of which can impact the relative success of retirement plans.