Sooner or later most senior executives consider switching to another company. Exciting new opportunities pose increases in career satisfaction and work-life balance. But when it comes to comparing the executive compensation packages and figuring out if you are better off leaving or staying – based on economics alone – it can be very tough to make an apples-to-apples comparison.
Many executives look to attorneys to help them negotiate a new package and this is a wise step. However, in our experience, attorneys often miss important details that can have very substantial financial implications. Most attorneys are not qualified, and do not have the experience, to examine the wide range of financial situations that may impact you.
Here are twelve important areas to closely analyze if you are thinking about switching companies. These are designed to help you look before you leap and develop a solid apples-to-apples financial comparison. Not all of these areas may impact your personal situation. But many of them will. A thorough and accurate financial comparison between employment options can bring clarity and peace of mind to what is already an emotionally charged situation.
Make sure you understand where you are now
Make sure you understand your current compensation package and have maximized its value. I often find, when speaking with senior executives, that they do not fully understand their current compensation package and because of this, they are missing out on opportunities. So whether you are thinking of leaving your current company or just wanting to improve the value of your current package, the areas below are important considerations. More to the point, you cannot make an accurate comparison between your existing employment package and new employment package until you have maximized your current opportunities.
Area 1 – Signing bonuses
Many executives are enticed to a new company by a sizable signing bonus. But in my experience, these bonuses, while nice, may not offset other factors. It’s important to look at the entire compensation situation both in the short-term and longer-term and compare this against your current situation.
For instance, a signing bonus of three times your current annual compensation is quite attractive. But if it requires you to move to a new state with higher state tax rates and you live there for ten years, you might actually lose money in the long-term versus staying in a state with lower taxes.
Area 2 – Salary bonuses
These can vary dramatically from one company to the next. Make sure you have a clear picture of both the short-term and long-term impact of salary bonuses and what you need to do to achieve them. A lower salary bonus that is more within your control to achieve could yield greater financial benefit than a higher salary bonus tied to a situation that is less within your control.
Area 3 – Short-term and long-term incentive plans
If your prospective new employer offers these, it’s important to understand the conditions that must be met to realize the incentives and if these are tied to individual or group performance. Short-term incentives may be tied to price-per-share increases while longer-term incentives can be tied to achievement of specific milestones. But the question you should ask yourself is – how much can I influence the attainment of the goal? The more the goal is within your ability to achieve, the greater the likelihood of financial benefit. But the inverse is equally true. As a percentage of total compensation, short and long-term incentives can be the make-or-break factor when considering a move.
Area 4 – Equity Compensation
There are several factors to consider here and each requires a close analysis to understand how, or if, it will benefit you at a new company.
- Non-qualified stock options are stock options which do not qualify for the special treatment accorded to incentive stock options. Non-qualified stock options result in additional taxable income to the recipient at the time that they are exercised, the amount being the difference between the exercise price and the market value on that date. Whether you do a cashless exercise, hold the stock or a combination of the two requires planning and management of risk.
- Incentive stock options provide certain tax benefits. On exercise, you don't have to pay ordinary income tax or employment taxes on the difference between the exercise price and the fair market value of the shares issued. But you may have to pay the alternative minimum tax instead. If you hold the shares for one year from the date of exercise and two years from the date of grant, then the profit, if any, is taxed as long-term capital gains which typically have a lower tax rate.
- Restricted stock concerns stock that is not fully transferable until specific conditions have been met. Upon satisfaction of those conditions, the stock becomes transferable by the employee. These have become a popular form of compensation for executives. Many companies choose to make the conditions to be satisfied both certain performance metrics and employment longevity. In other words, you may need to remain at a company and help it perform very well to meet the conditions of restricted stock transfer. But if the conditions of transfer include earnings per share goals or other financial targets over which you have little control, it may be very difficult to realize value from restricted stock.
- Phantom stock is another popular form of compensation for closely held corporations. A company promises to pay cash at some future date, in an amount equal to the market value of a number of shares of its stock. This means the payout will increase if the stock price rises or decrease if the stock falls, but without the recipient actually receiving any stock. The bad news is that phantom stock payouts are taxable as ordinary income.
- Employee stock ownership plans (ESOPs) provide executives with an ownership interest in a company. Among equity-based compensation options for executives, ESOPs are often the lowest common denominator. There are annual limits on the amount of deductible contributions an employer can make to an ESOP because they are carefully governed by federal pension laws, called the Employee Retirement Income Security Act (ERISA). ERISA disallows "preferred" classes of participants in an ESOP and requires that all employees must be treated proportionally the same. Internal Revenue Code section 404(a)(3) limits deductible contributions to twenty five percent of the compensation otherwise paid or accrued during the year to employees.
Area 5 – Supplemental employee retirement plans (SERP)
A SERP is a non-qualified retirement plan for executives that provides benefits above and beyond those covered in traditional company-sponsored retirement plans. Typically, both the employer and employee contribute to the plan to help executives save substantial additional retirement dollars. These plans can be compared to a deferred compensation plan. SERPs allow for flexibility in plan design and can offer a significant advantage to certain executives who need to accelerate their retirement savings.
Area 6 – Medical benefits
While these plans are often taken for granted, health insurance events can be a major source of financial drain. Many progressive medical insurance plans now support preventive medicine. These can be very important because no matter how much money you make, you cannot enjoy it if you are ill. If you have a loved one with a pre-existing medical condition that requires expensive care, then a medical benefit plan becomes even more important to your financial health.
Area 7 – Financial planning perk
Some progressive companies are now including, as part of their annual compensation for executives, the fees of a financial planner. This can be as much as ten thousand dollars a year, depending on the employer. Smart companies want their executives to focus time and energy on their business, not the executive’s personal finances.
Area 8 – Disability insurance
This concerns both long-term and short-term disability. It’s important here to understand which types of insurance are being offered and how adequately they protect you from loss based on your actual compensation – not the insurance company’s perceived risk. It’s also important to analyze specific terms to understand their definition of “disabled.” Only then can you know if you need to buy supplemental disability insurance and how much this will cost annually.
Area 9 – 401k plans
401(k) plans are defined contribution plans that limit contributions to $17,500 annually as of 2013. Contributions are tax-deferred, meaning that they are deducted before taxes and then taxed when a withdrawal is made from the 401(k) account, usually when an executive has retired and is in a lower tax bracket. Many employers now match contributions and this is where we see executives make some pretty big mistakes.
For example, matching contributions from certain employers are allocated over the course of a year. If an executive contributes all $17,500 within the first three months of the year, they will lose matching dollars for the other nine months of the year (which could equate to thousands of dollars). In this case, it is better to distribute 401(k) contributions evenly over 12 months to maximize the matching contributions.
Area 10 – Pension plans
Depending on the employer, pension plans can be the primary retirement vehicle that is funded. These are defined benefit plans. Municipal, state and federal governments prefer these plans as do many universities. Pension plans share some common characteristics but do differ in a few important ways, including how they calculate pension benefits and how they pay out upon retirement. This can make a huge difference in the after-tax funds you might realize at retirement.
Area 11 – Change-In-Control Agreement
These agreements concern how executive compensation is handled if a company changes hands. For instance, if a company is bought out by another company, how will executive stock plans be impacted? What happens if an executive is in year three of a five year vesting period? If the executive is let go, how is severance handled? Change-in-control agreements can go a long way toward protecting incoming executives who may be leaving a lot behind at their old company.
Area 12 – Moving costs
If a new position requires you to move, there are many factors to consider that will influence your financial situation. I prefer to conduct a thorough relocation analysis that includes at least these factors:
- Cost of moving. Many employers will pay moving costs. But don’t let this rank too highly in your list of priorities. While it may cost you nothing to move your belongings, other factors could cost you dearly. This is a nice benefit and a gesture of good will from a new employer. But moving costs usually will have a negligible impact on long-term financial standing.
- Cost of living adjustments. This concerns increases or decreases in cost of living associated with a new area. This is especially important if you are moving internationally. Some employers offer cost of living adjustments, additional monthly compensation, for more expensive areas where they have an office. It’s important to know if this is available to you.
- Cost of housing. A four-bedroom penthouse in downtown Chicago will have a different cost structure than a four-bedroom home in the Denver suburbs. Cost of housing changes can have a major impact on long-term wealth creation.
- State tax rates. This could be a huge factor in how much after-tax money you retain. If you are moving from a state with a higher tax rate to a state with a lower tax rate, the balance swings in your favor. But the opposite is equally true.
As you can see, there is a great deal to consider when comparing compensation packages. Usually these comparisons are best made with the support of a qualified financial professional who can help you consider the details of each package. Because executive compensation is a huge part of the overall financial plan we develop for clients, we have acquired a knack for uncovering important details. These details can be the difference between realizing or missing out on thousands of dollars annually and hundreds of thousands or more over several years.
Whitnell is not a law firm and does not give legal advice. The information contained herein should not be construed as legal advice or a legal opinion on any specific facts or circumstances. The contents of this article are intended for general information purposes only, and you are urged to consult a lawyer concerning your own situation and any specific legal questions you may have.