What’s your RSU strategy?

The Deferral and Diversification of RSUs

EBS Managing Director, Chris Rich, was invited to join My Financial Coach for their quarterly economic update, The New Tax Bill, the Economy and How to Plan.  This event was hosted by fellow EBS Managing Director (and President/Founder of My Financial Coach), Bill MacDonald.  We also heard from two fellow subject matter experts and keynote speaker, Dr. Arthur Laffer.

Given that one of our areas of expertise is nonqualified deferred compensation plans, Chris was asked to briefly discuss tax planning strategies and ideas related to the deferral and diversification of restricted stock units.

One of the trends we have been seeing in plan design is the ability to defer restricted stock units in addition to cash compensation (salary and bonus).

Plan Design and Changes in Equity Compensation

By way of introduction, Chris noted the evolution in equity plan design over the last fifteen years or so in which there has been a significant shift from stock options to restricted stock.  Stock compensation is typically the largest component of executive compensation packages, and it is now common to see a portfolio approach that includes both options and restricted stock or restricted stock units.

Restricted Stock Units versus Restricted Stock

Going a step further, restricted stock units represent several advantages over restricted stock.  For an organization, RSUs can result in more simplified record keeping and they do not require upfront issuance of shares.

From the executive’s standpoint, income taxation can be deferred with restricted stock units, but not with restricted stock.  With both, vesting can trigger taxation.  But with RSU’s, they can be deferred under a company sponsored Deferred Compensation Plan, restoring to the executive the ability to control the timing of taxation through distribution elections, and allowing far more flexible planning options.

The Diversification Issue?

However, one issue that comes up with the deferral of RSUs is the concern by some executives of having a significant asset tied to the performance of company stock over a long period of time.  EBS has addressed this by implementing a plan feature that allows an executive to diversify or reallocate a portion of their RSUs into other notional investment options under the plan.

As Chris mentioned, what we have found at EBS is that many public companies do offer the deferral option for RSUs, but very few offer the ability to diversify or reallocate within the deferral account.  The fear is that this will trigger negative accounting issues, requiring a move from fixed to variable accounting.

But EBS has worked with several of the largest accounting firms and developed an accounting methodology that negates negative accounting that could be triggered in plans that do permit deferral and diversification.

Invest In Your Top Talent

In summary, Chris’ message to companies was to not overlook the value of adding the option to not only defer but diversify restricted stock units to their deferred compensation plans.  This can be a major enhancement to the ability for an organization to continue to attract, retain, and reward top talent – which never goes out of style.

You can reach our in-house expert, Chris Rich (former tax partner at Ernst & Young) directly by email at: crich@ebs-boston.com (this will be a hyperlink), by phone at 617-904-9444 x2, or via LinkedIn by clicking here (this will also be a hyperlink)

What are you waiting for? Time is of the essence when it comes to your investments.

 

 

Have you read our series Executive Stock Wealth in the Age of Distraction?  We share valuable information and discuss the shift from stock options and restricted stock to restricted stock units (RSUs).

EBS Restricted Stock Blog Series Blog 3

How can I maximize the value of my RSUs?

The Deferral and Diversification of Restricted Stock Units

In the first blog in this series, we discussed how the design of long-term equity compensation plans has evolved from a primary emphasis on stock options to the portfolio approach commonly used today.  And within the portfolio of equity compensation awards, Restricted Stock Units, both time-vested and performance-vested, have become the vehicles of choice for many companies because of the flexibility of plan design, potential tax advantages and simplified stock plan administration.

In the second blog, we provided a hypothetical analysis illustrating the potential advantage of the deferral of taxation upon vesting and discussed the issues associated with participation in a non-qualified deferred compensation plan including; the timing of deferral elections in general, and the opportunity for a “look back” election with respect to prior year grants.  In addition, we reviewed the potential benefit of the active management of distributions.

In this third blog in the series, we address the issue of diversification; that is, the ability of a participant in a non-qualified deferred compensation to reallocate some or all of the RSUs deferred to other notional fund choices offered under the plan (such as a notional S&P 500 fund).

Deferral and Diversification

There can be significant advantages to permit the deferral of taxation on RSUs upon vesting through a non-qualified deferred compensation plan.  Federal income taxes can be deferred and, in some cases, state income taxes can be reduced or eliminated entirely. In addition, distributions can be managed in a manner consistent with the executive’s overall financial and tax plans.

As a result, a number of publicly traded companies permit the deferral of RSUs; however, few permit diversification.  This creates a unfair disadvantage of deferral as it precludes the opportunity to diversify company stockholdings as an executive might do if he/she accepted delivery of the shares upon vesting, paid the related income taxes and then diversified the remaining shareholdings to avoid a concentration of net worth linked to company stock.

The reason most cited by plan sponsors for not offering diversification of RSUs deferred is that permitting the reallocation of the RSUs to other notional investment choices in the deferred compensation plan and the payment of benefits in cash at the end of the deferral period, would trigger accounting issues.

That is not necessarily the case. If the conditions on which diversification is permitted are properly structured, “liability” accounting treatment would not be required until such time as an executive chooses to reallocate the RSUs deferred to other notional fund choices in the deferred compensation plan. The conditions for diversification might be a specified holding period for the RSUs deferred, a specified age, retirement, or upon a change in control.

Result

The net P&L impact of permitting the deferral and diversification of RSUs through a properly designed non-qualified deferred compensation plan would be comparable to that for RSUs that are distributed as shares at the time of vesting; that is:

  • The date of grant value would be recognized as compensation expense over the vesting period,
  • Any appreciation in value of RSUs deferred from the date of grant to the date of diversification would not impact the P&L,
  • If and when an executive choses to diversify the RSUs deferred through reallocation to other notional funds offered in the deferred compensation plan, “liability” accounting would kick-in and the value of the participant’s deferred compensation account would be marked to market through the P&L from that point forward.
  • However, that expense would be offset by the investment income from the rabbi trust assets purchased to hedge the deferred compensation plan liability (e.g., an S&P 500 Index Fund).

In Summary

It may be possible to significantly enhance the value of the total rewards package for senior executives by permitting the voluntary deferral and (subject to specific requirements) diversification of RSUs deferred without triggering accounting issues.

RSU Blog #4:  Final Blog in the Series

In the next and final blog in the series, we will recap the benefits of permitting the deferral and diversification of RSUs including the opportunity for a “look back” deferral election for prior year grants.  In addition, we will discuss the implementation steps and administration issues associated with permitting deferral and diversification.

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P.S. We’ll announce when blog #4 from the series is live, via LinkedIn.  If you don’t want to miss it, be sure to follow us by clicking the link here!
Caveat:  EBS is an executive benefit consulting firm.  It does not provide accounting or tax advice.  The tax and accounting treatment described above for the deferral and diversification of RSUs is based on the firm’s experience working with its clients and their advisors on similar plan designs.