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Cash Flow: Planning to Fund Major Purchases

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Work with your advisors to adopt best practices and plan for funding major purchases.

For many executives, challenges surrounding funding major expenditures such as primary and secondary residences, homes for adult children, and children’s or grandchildren’s weddings are rooted in concentration and regulatory issues discussed in Maximizing Executive Compensation.

While the executive’s balance sheet is frequently more than adequate to fund such large-ticket items, restrictions on the disposition of equity-linked compensation can constrain liquidity. This is due to regulatory limitations for executives of public companies and limited markets and buy-sell restrictions for executives of private firms. The funding of major purchases is therefore inextricably linked to cash-flow planning. 

Given the stark shift in compensation structure and constraints upon becoming a senior executive of a public or private company, best practices and planning techniques vary over one’s career. You will want to plan in advance of a shift in compensation as well as for when you are in the C-suite. 

Plan in Advance of a Shift in Compensation

As your career progresses, your compensation shifts from traditional cash compensation to increasing levels of equity-linked compensation. This transition happens over time, and many executives are aware that they are on the senior leadership track well before reaching the C-suite. This time period represents an important planning opportunity.

Take advantage of cash compensation to accumulate cash and noncompany holdings. Regardless of your faith in your company, your concentration risk extends well beyond options and common shares – it includes your salary, bonus, benefits and deferred compensation. Take the years prior to the expected shift in your compensation to build cash reserves and diversify in more liquid assets. The need is particularly acute for executives of public companies who are likely to be constrained by insider status in the future. For example, instead of reinvesting your cash bonus in company shares, consider placing it in a diversified portfolio. When you do reach insider status, these assets can be used to fund purchases and, unlike company shares, serve as collateral for lines of credit.

Prioritize and plan

Work with your advisors to establish a disciplined approach to building a foundation for goal funding. Just as you seek stability for your company, you will want to plan to achieve long-term stability for your family and prepare for unforeseen events. In addition to building up taxable and diversified savings accounts, plan for and prioritize core lifestyle goals such as funding children’s college savings plans. Major purchases such as vacation homes, sometimes referred to as “discretionary purchases,” are, after all, often discretionary.

In the C-Suite

For most senior executives, equity-linked compensation far outweighs salary and cash bonus. Generally, such equity concentrations are relatively illiquid due to: 

  • Executive stock ownership requirements 
  • Timing considerations around vesting and equity releases
  • Tax considerations
  • Agreements and regulations necessitating permission from the board/general counsel for disposition of shares
  • Securities, reporting and other regulations governing public company stock activity 
  • Limited open window periods for public company stock
  • Limited markets for private company stock
  • Public perception
  • Relatively high concentrations of options and/or restricted stock as opposed to common shares 

Consequently, executives often achieve liquidity for major expenditures via a traditional mortgage for a home purchase, or a line of credit against non-company assets. Which is more effective will be dependent on your personal circumstances, interest rates, timing and market conditions.

Unexpected expenses

It is worth noting that very senior executives can face significant expenditures related to company culture. One may feel it necessary, for instance, to purchase a prominent residence, or even residences, for company-related entertaining; join numerous clubs and boards; and make significant charitable donations. While most executives have planned well in advance for expenses such as children’s education, being wholly prepared for expenses associated with your role is not as common. 

In addition to the cash-flow planning techniques discussed below, if you are an executive of a public company you will want to explore the possibility of establishing a 10b5-1 plan for the predetermined sale of equity-linked compensation.  

Judiciously defer 

The potential benefits of the deferred compensation plans available to many executives are well-known and myriad, allowing income to grow tax deferred for many years. Distributions represent another source of funds to meet lifestyle goals in retirement, when your taxable income is expected to be lower and, perhaps, you are domiciled in a lower-tax state.

It is therefore common in our experience for executives – who often possess profound faith in and loyalty to their companies – to seek to maximize their non-qualified deferred compensation plans (NQDCP), representing at rates exceeding 50% of salary and bonus. Doing so, however, can impact cash-flow, and may heighten stock concentration and risk as an unsecured creditor of the company’s supplemental savings plan. 

Consider deferring enough to maximize your employer match, while working with your financial advisor to model for cash-flow needs. Remember that even if your NQDCP is not invested in company stock it is still subject to company credit risk and is not protected by the Employee Retirement Income Security Act (ERISA), which provides some protections to qualified retirement plans.

Withhold at a higher rate for equity award releases 

Typically, when an executive has a stock option exercise or equity-linked compensation vesting, the company withholds taxes – often at the statutory rate – and the executive receives net shares. It is often worth considering asking your company to withhold at a slightly higher rate than your effective rate. At a minimum, you will avoid owing tax on the difference between the statutory and effective rates and minimize cash outflows for tax purposes. For executives of public companies, the withheld shares are not reflected as a ‘sale’ disposition on SEC Regulatory filing Form 4 (Changes in Beneficial Ownership). Executives of both public and private companies will want to remain aware of reporting requirements at the time of transaction.

Work with your financial advisors to model

Creating a financial plan that results in adequate cash flow and the ability to efficiently fund major expenditures throughout your career necessitates, to the degree possible, anticipating such purchases as well as nuanced, sustained cash flow management. Your advisors need to have a thorough understanding of and deep experience modeling the varied buckets of assets, dates and timing of inflows, and tax treatments.

In practice, it is often a combination of techniques that prove most effective. For instance, in the event the executive is holding in-the-money options approximately 75% of the way through the life of the option, they may consider exercising the options. Generally, this is close enough to the expiration date to demonstrate sufficient confidence in the company, while avoiding the possibility of the option losing its value near expiration, or being locked out of activity involving the stock due to blackouts or other restrictions. In tandem, the executive could potentially have requested their company withhold taxes on the exercise higher than the statutory federal rate, withholding the balance to common shares. If the common shares pay a dividend, the executive has successfully de-risked while converting the option to a dividend-paying asset that supports cash flow.

For common effective gifting techniques for corporate executives to gift to family and charity, see Legacy Planning: Supporting Family and Causes.

Executive

Create a Cash-Flow Strategy

Our advisors can help you plan for major purchases.

THE NORTHERN TRUST INSTITUTE

Proven Advice for Moments that Matter

Disclosures

This information is not intended to be and should not be treated as legal, investment, accounting or tax advice and is for informational purposes only. Readers, including professionals, should under no circumstances rely upon this information as a substitute for their own research or for obtaining specific legal, accounting or tax advice from their own counsel. All information discussed herein is current only as of the date appearing in this material and is subject to change at any time without notice.


The information contained herein, including any information regarding specific investment products or strategies, is provided for informational and/or illustrative purposes only, and is not intended to be and should not be construed as an offer, solicitation or recommendation with respect to any investment transaction, product or strategy. Past performance is no guarantee of future results. All material has been obtained from sources believed to be reliable, but its accuracy, completeness and interpretation cannot be guaranteed.

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