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Mergers and acquisitions are a common business strategy and often result in a realignment of talent among mid- and upper-tier executives. Many jobs are eliminated and severance packages offered. If your company has recently been acquired or will merge with another company, it’s wise to consider taking immediate action to preserve the compensation you have earned. In addition, it makes sense to develop a financial strategy aimed at deploying money from stock options, restricted stock grants, deferred compensation, severance, and other sources to minimize taxes and invest wisely for your future.
If This Happens to Your Company, What Should
Once your company announces the deal is happening, here are the top questions and concerns people have as it pertains to their personal finances:
- Will I keep my job?
- If my job is eliminated, what should I do? Do I have to keep working?
- What will happen with my 401(k) and other retirement savings?
- Will my stock options and restricted stock vest, or be immediately cashed out?
- Will my deferred compensation plan have an accelerated payout?
- How can I minimize taxes if I need to cash out stock or retirement accounts, which will balloon my income?
- How will my health, life, disability, and other insurance plans change?
Losing Your Job – The Importance of Making the Right Choices
Even if your position is likely to be eliminated, there is usually time to make key decisions. It often takes several weeks or months to develop and execute strategies on the new management structure and key jobs in the combined organization. If you lose your job in the process, you will likely be offered a severance package and need to make decisions relating to your stock grants and other compensation plans.
Here are some of the key items to consider:
Severance Pay – Lump Sum or Serial Payments
Severance pay may be made in a one-time lump sum payment, or follow the companies’ regular payroll cycle of monthly, semi-monthly or bi-weekly checks. If you are receiving a lump sum payment, naturally one question to consider is: What can be done to minimize the income tax impact of receiving this large cash payment? Depending upon how far in advance you can prepare, there are several strategies that should be considered.We will discuss these income tax reduction strategies throughout this paper.
While a lump sum payment may feel like a “windfall,” it’s important to have a plan for this cash. You may be in a position to save and invest it for your future, or you may want to hold it in cash until your future cash flow needs are clearer. It can also be an opportunity to enhance your children’s college savings accounts, pay down debt, or build a nice cash reserve as part of your investment and withdrawal strategy during retirement. If you don’t have a plan for this cash, the “windfall” could quickly disappear.
If you are receiving serial payments, you’ll be able to budget your cashflow as you’ve done in the past. You still need a cashflow plan for when these payments run out. If you are heading into retirement, your portfolio will likely become your source of income, and you need to know what accounts you’ll be taking money out of first, second, etc. along with which investments are best to liquidate. Or if you land another job during the time you’re also receiving serial severance payments, use the severance checks to propel your financial plan forward – this can help you get to retirement months or years earlier than planned.
Severance pay is subject to ordinary income tax, and you cannot defer any of this payment into your 401(k) plan or deferred compensation plan as it is paid following your termination date. If your severance is paid in a lump sum, it can bump you into a higher tax bracket. Even though income taxes will be withheld from your severance pay, it may not be enough to cover your personal tax liability. This is a great time to work with a tax professional to determine if you need to make estimated tax payments.
401(k) Retirement Savings Plan
Once you learn your job is eliminated, one of the first items to address is to ensure you maximum fund your 401(k) plan prior to your actual termination date. For 401(k) deferrals that are made on a pre-tax basis, this tax savings will be valuable in your final year of employment at your company, especially given any severance payments received.
For example, let’s say your termination date is June 15, 2021 and there will be five pay periods prior to your termination date. You may need to adjust your 401(k) contribution percentage so that the IRS maximum of $19,500 is deferred into your 401(k) plan prior to your termination date. If you are age 50 or older in the year of termination, you should also fund the “catch-up contribution” of $6,500 before you terminate employment. Even if you do secure another job later in the year, you’ll at least know you already took full advantage of this pre-tax deferral opportunity.
Upon termination, you have a few options with your qualified 401(k) plan. First, you can leave your account where it is. Your balance will continue to be invested as you’ve directed from the list of available investment options, and it will continue to grow on a tax-deferred basis. You can still access your account balance on the 401(k) website. Withdrawals are not required until you are age 72 when the IRS required minimum distribution rules apply.
If you are between the ages of 55 and 59½ when you terminate employment with your company, and you think you may need to make a withdrawal from your 401(k) plan before you are 60 years old, you may want to leave all or a portion of your balance in the 401(k) plan. There is a special rule that applies to 401(k) withdrawals where you can avoid the 10% early withdrawal penalty (that generally applies to distributions from retirement accounts prior to age 59½) if you are at least 55 years old in the year you separate from service. We have advised some clients over the years to leave a portion of their 401(k) balance in the company’s 401(k) plan until they are age 59½, when the 10% early withdrawal penalty would no longer apply to any retirement account.
Next, you also have the option to rollover your 401(k) balance to another employer’s plan or to an IRA in a tax-free transaction. Upon instructing the 401(k) provider that you would like to commence a rollover of your 401(k) account to an IRA, they will liquidate your holdings and process your distribution request. However, you can often transfer the shares of your company stock from your 401(k) account directly into an IRA.
The first distribution payment represents your “pre-tax” balance. You will want this money transferred to your IRA custodian. This distribution should absolutely not be deposited into your personal bank account. If applicable, a second distribution may be made which represents any “after-tax contributions” in your 401(k). The “after-tax contributions” are the dollars you already paid taxes on over the years, and then deposited into your 401(k) from your paycheck. Typically, clients directly deposit this after-tax amount into their Roth IRA but you can also receive it in cash and deposit it into your personal bank account.
For someone who has been investing in their company stock inside their 401(k) plan for a very long time and has low “cost basis” shares, a tax strategy known as Net Unrealized Appreciation (NUA) may be beneficial. If it’s the right scenario, NUA could save you thousands of dollars in income tax. With this strategy, you are able to transfer some or all of your company stock in your 401(k) plan to a brokerage account at termination, and then sell the shares in the brokerage account, paying long-term capital gain tax rates. Ordinary income taxes will be due on the cost basis of the shares distributed out of the 401(k) plan, not the fair market value of those shares. Plus, if you are charitably inclined and incorporate a gift of shares to charity in the year of this transaction, you could greatly minimize the overall tax impact. It is important to consult an expert before proceeding as there are many requirements for this to work properly. NUA should be evaluated before diversifying large amounts of company stock inside your 401(k) plan, or before initiating a rollover to another retirement account. At Brightworth we provide our clients with investment and planning advice on their 401(k) based on their unique situation.
Finally, a beneficiary should be named on your 401(k) account, which is an important part of everyone’s estate planning. If you rollover your 401(k) plan to another retirement account following termination, you will need to make sure your new beneficiary designations are properly coordinated and integrated with your overall estate plan.
Supplemental Non-Qualified 401(k)
A Supplemental 401(k) plan is different from the qualified 401(k) plan. It is a non- qualified plan and is only available to select highly paid employees at a company. For many executives, this plan will pay out in cash shortly following termination. The value of this account is subject to ordinary income tax the year the proceeds are distributed to you, and some income tax will be withheld from this distribution. Again, it may not be enough to cover your personal tax liability on the payout of this plan that year.
Since the payout and income tax ramifications of the 401(k) plan and Supplemental 401(k) plan are different, you may have had a different beneficiary structure for each to optimize your estate plan. Also, you could have been counting on the Supplemental 401(k) plan balance to fund a trust for estate planning reasons in the event of your death. Since this account is typically liquidated following termination, you may need to revisit your estate funding plan.
A change in control in your company can mean that thousands of unvested shares of common stock will now be fully vested. The gain in your stock options may become the largest asset on your balance sheet. This also means a large part of your overall net worth is tied to company stock. We are often asked, “How much of my net worth should I hold in a concentrated stock position?” We typically recommend a client have enough diversified assets by the time they are entering the “withdrawal phase” of their life to cover their core living expenses and taxes. Above this core level, concentration in a single stock position does not pose as much risk to your financial strategy. We recommend always having a predetermined strategy for your stock options as it can provide confidence and peace of mind to make these critical decisions.
This exercise strategy will likely need to change as a result of the merger or acquisition, as your time frame to exercise is often shortened. The acquiring company may require you to exercise the stock options within three to six months of the merger or your termination date. This could cause your income to skyrocket for the current tax year.
Next, you may be able to convert these shares into the acquiring company’s stock. This means the number of shares and the price per share will change after the merger. Additionally, if you remain at the new company, a new stock option plan may be created, so any new options you are granted could have a different framework. This may affect provisions around retirement, death, disability, vesting and expiration periods.
Since stock option proceeds are subject to income tax upon exercise, part of your exercise strategy should include income tax planning. For example, perhaps you can exercise a portion of your options next year while staying just under the top marginal tax rate. If you have any chance of staying out of the top tax bracket when you exercise options, especially in the year you receive severance pay, this also saves taxes on other parts of your financial picture such as dividends, interest, and capital gains from your brokerage accounts. Also, don’t forget that if you are in a federal tax bracket above 22%, you’ll want to hold back some cash from your non-qualified stock option proceeds to pay for the additional tax due (i.e., being in the 37% federal bracket versus the 22% federal tax withholding on your non-qualified stock option exercises). Once your compensation exceeds $1 million, under current tax laws the federal withholding on non-qualified stock options will be at the 37% tax rate. Incentive stock options are taxed differently and subject to the Alternative Minimum Tax calculation. Income taxes are not withheld upon exercise of an incentive stock option, however, be sure to consult with a tax professional to understand your tax liability when you file your tax return that year.
Stock option income can play a significant role in your wealth accumulation and cash flow strategy. It’s important to have a plan in place especially if you have a limited window to exercise your options.
Restricted or Performance-Based Stock
The merger or acquisition may require that this form of compensation be cashed out. If so, there will be a significant impact on income taxes due because you are receiving this income earlier than expected, and all at once.
As many executives hold much of their wealth in their employer’s stock, by being forced to liquidate unvested restricted stock, the concentration of stock held in just one company will suddenly decrease. This could have an impact on your overall investment strategy as your allocation to stock has declined, and allocation to cash has ballooned.
If your vested company stock converts to shares in the new organization, be sure to track any adjustments to cost basis as this will have an impact on your taxes when you sell the stock. There may be a one-for-two conversion of old stock into the new stock, with cash received from fractional shares. Determine your cost basis for each share of stock you own before the merger, and write down any adjustments to cost basis for your new stock post-merger. Depending upon how long you’ve held your company stock, the gain will be taxed as either a short-term capital gain at your top marginal tax bracket (as high as 40.8% for federal tax including the current 3.8% Medicare surtax) or a long-term capital gain up to a 23.8% rate. And don’t forget about state income taxes.
Finally, if you are staying with the new company, the new restricted stock plans could be very different. For example, stock plans based on performance may have different measures compared to your old firm. It’s also possible that executives at your level may not qualify for stock grants.
Much like other stock plans and grants, any funds from a deferred compensation plan could be cashed out as part of the merger or acquisition. Don’t assume the payout elections you have on file with your deferred compensation plan administrator are correct – as there could be different payout provisions that rule due to change in control. Your entire deferred compensation plan balance could pay out in lump sum whether you remain at the new company or leave, resulting in a large tax bill. Because a lump sum will be taxed as ordinary income, approximately 40 percent or more of this money could be subject to taxes.
If you find your deferred compensation plan is going into payout mode, make sure you have a plan for this cashflow and the income tax bill. We’ve helped many clients use this accelerated payment to top off their children’s college accounts, fund charitable giving goals, eliminate their mortgage, and build retirement savings accounts.
For those staying on at the company, a new deferred compensation plan may work differently than the old plan – or there may not be any deferred compensation program. This will likely mean drastic changes to your savings strategy and tax status, especially if you’ve been heavily participating in the past.
If you have been fortunate to work for a company that still offers a traditional pension plan, you will have major decisions to make regarding the timing and payout election for your pension. First, understand the earliest date you can commence your pension. If you are age 50 and your pension can’t begin until age 65, you’ve got time to plan. However, if you can commence your pension now or within the next few years, it’s important to run the numbers and understand the pros and cons of commencing early.
With many pension plans, there are early reduction factors if you take your pension benefit before a certain age. However, pension formulas are often subject to prevailing market interest rates, and if interest rates are higher in the future, that could mean your pension benefit is worth less than if you took it early today.
Next, calculate your break-even age. For example, let’s say you are age 55 and commence your pension today. The pension benefit is $3,000 per month today, so over the next five years that will equate to $180,000 of payments. If you wait for five years to commence at age 60, and your projected pension benefit is $4,000 per month, that’s a 15-year break-even. It will take until you reach age 75 to receive the same total pension benefits.
Consider whether you need this pension income to meet your living expenses now, which could be the case if you would otherwise be liquidating investment accounts to pay your bills. Rather than liquidate your investments heavily in early retirement, or paying a 10% early withdrawal tax penalty on retirement accounts, starting your pension early could make a lot of sense.
A primary question clients ask us is, “What pension option should I elect?” You may have options such as a lump sum, or monthly pension over your single life or joint life with a spouse or partner. Almost everyone wants to know: “Should I take the lump sum?” “The monthly annuity seems stable, but what about inflation?” While the answer does depend upon each person’s particular situation, there are a number of factors to consider such as 1) your age and health at termination, 2) whether you are married, 3) whether you have any other pensions or stable monthly income streams, 4) if you plan to go back to work, and 5) how soon you will need to start living off of your retirement assets. Finally, we look to determine what percentage of your future retirement income is coming from “you” (i.e. your portfolio, consulting income), versus Social Security, versus a company pension plan, as this can help you make a decision.
Inflation is a major consideration when planning for your retirement and it’s likely that your purchasing power will decline over the years if you take the monthly pension (as most don’t increase for inflation). If you take the monthly annuity, you’ll need more growth on your investment portfolio during retirement so you can withdraw larger amounts each year and preserve your inflation-adjusted standard of living.
Furthermore, individuals with significant liquid assets may want to look at other pension options such as a lump sum from the pension plan. In cases where a lump sum makes sense, the proceeds can be rolled over directly to an IRA, deferring the taxes on the lump sum for years to come. Or, if you are planning to go back to work and have several years to invest and grow your lump sum pension in an IRA, electing the lump sum distribution option may be the right choice for you. The lump sum, if not entirely spent during your (and/or your spouse/partner’s) lifetime, can be passed down to the next generation which can be an attractive feature.
If you have been participating in a non-qualified pension plan (or supplemental pension plan) your payment options may be different. Even if a lump sum payout is offered, it can’t be rolled over to an IRA and will be subject to tax upon payout. When running financial calculations, it’s important to keep in mind the immediate taxation of any lump sum payments from a non-qualified pension plan – the value shown on your statement is a before-tax number and will be eroded by income taxes upon payout.
Brightworth has helped a number of people make wise choices with their pension payout elections. Having a clear picture of how your pension coordinates with your overall cash flow and investment strategy is one of the “large rocks” to address.
As a fee-only firm, Brightworth does not sell insurance products. However, insurance planning is an important component of our clients’ overall financial strategy. We have found over the years many individuals working in corporate America have the bulk of their health, life, and disability insurance through their group plans. If you are staying on with the new firm, don’t be surprised if you have a whole new set of benefit plans available to you, so you’ll be starting from scratch to make sure you have the right amount and type of insurance coverage.
If you leave your company, your benefits will change.
For our clients, we look at whether they are eligible for retiree medical coverage following their termination of employment and if not, whether going on COBRA is the best short-term solution. Often severance packages contain provisions to cover COBRA premiums for a period of time. Researching individual or family medical health plans is usually wise to compare costs and coverages before COBRA ends, especially if you plan to continue working as a consultant or at a smaller-sized company.
For life insurance, you need to evaluate how much coverage you should maintain, for how long, and the cost to convert your group coverage to an individual policy versus getting a new policy elsewhere. It’s likely you can continue some or all of your group life insurance after your separation date by converting the group policy to an individual, permanent policy. The premiums on converted life insurance policies may be much higher than you would pay in the general marketplace to purchase a new policy, if you are healthy. In general, having some of your life insurance coverage outside of your employer is beneficial should a life event such as job elimination occur, as this is one less obstacle to face. Make sure your beneficiary designation is updated for any new life insurance policies you secure following termination, and if you do plan to apply for outside coverage, make sure you are insurable before canceling any existing coverage.
Your disability insurance typically ends once you are no longer employed by your company. Individual coverage is typically expensive and may be hard to qualify for, so if you need to keep working, finding a job with good benefits has its advantages.
If you have funds in a Health Savings Account (HSA), this money is not forfeited and you can keep the account in-tact. You can also roll it over to a different HSA in the future if that makes sense for your situation. Remember to name a beneficiary on your HSA account too. And every year that you are enrolled in a high deductible medical plan, be sure to save the maximum amount into the HSA as this is a valuable tax strategy. The deposits you make go in pre-tax, the interest earned inside the account is not taxed, and withdrawals for qualified medical expenses come out tax-free. It’s the triple tax play!
Insurance planning is another important element to consider if you leave your job, and can be more stressful especially if you’ve experienced any health issues in the recent past. This is an area we are happy to help our clients navigate through, working closely with their insurance agent or one that we trust. Brightworth has relationships with independent health insurance consultants who help our clients navigate these important decisions.
When a merger or acquisition of your company happens, your money is on the move. It often results in an acceleration of income due to stock plans paying out, deferred compensation being liquidated, severance pay, and other non-qualified pension plans coming due. Here are some key steps to take to minimize your taxes:
Contribute the maximum amount to your 401(k) retirement savings plan before your termination date. This move will help reduce income taxes in the year of the merger or acquisition. For 2020, people younger than 50 can contribute up to $19,500 and those 50 and over can contribute $26,000. If you cannot contribute the maximum amount under the old employer’s plan, make certain to contribute the maximum amount when you combine plans offered by the old employer and a new one.
If you participate in a Health Savings Account, contribute the maximum amount if you choose a high-deductible plan. Contributions can be made until April 15 of the following year for the prior tax year. This means you don’t need to make all of these contributions before leaving the job or before the end of the year. If you are not in a high-deductible plan for the entire year, your contribution limit will be pro-rated.
Defer taking capital gains in your taxable investment portfolio in the same year you’re receiving severance or other large payouts, and harvest capital losses to offset gains you incurred earlier in the year.
Review opportunities to qualify for state tax credits for special programs. For example, in Georgia, executives can purchase film credits to help reduce the state income tax burden.
For executives who make charitable contributions, consider setting up a Donor Advised Fund. This fund enables a person to contribute a large amount of money in one year to fund charitable gifts for several years. You can deduct the entire amount given to charity in the year it is made, which will reduce your tax bill. Appreciated company stock is often a great tool to fund the donor-advised fund, as when the stock is liquidated inside the donor-advised fund account, no capital gain taxes are due.
If your financial condition is sound – especially after receiving stock options and other payouts -- it may be a good time to help out family members in need. Any person can make gift up to $15,000 -- $30,000 if you are a married couple -- to an unlimited number of people each year and not file a gift tax return. Another favorable gifting strategy is to pay someone else’s medical or tuition bills directly to that institution. The law allows any person to contribute an unlimited amount of money under the gift tax law.
Contribute to your child’s or grandchild’s 529 college education savings plan, which may result in a break on state taxes. These plans offer tax-free growth if the money is used for qualified education expenses and could be a good use of cash.
A sound investment strategy is the cornerstone to building and preserving wealth. It should be designed to meet your specific cash flow needs, time horizon, growth requirements, tax objectives, and risk tolerance. Successful investing requires a long-term perspective and discipline to avoid making short-term emotional mistakes. Having a coordinated and comprehensive strategic asset allocation is the foundation for your
If you’ve been a long-time employee of your company, it could be that your entire investment strategy has been determined based upon the available funds in the 401(k) plan and deferred compensation plan. Once employment ends, your investment strategy could transition into a portfolio 100% outside of the company’s offerings. Having flexibility with your investment options is good, but can be overwhelming at first given all of the other questions you’re needing to answer once during a time of transition. You may suddenly be in a position where you are in “withdrawal mode” after spending 20 or 30 years in “accumulation mode.” This requires a different investment strategy, perhaps one with more bonds, cash, or alternatives. Or you may need to live off your investments for a short period of time until you secure another job. Determining how to adjust your investment mix, what account to draw from first, and how to minimize the tax implications of each withdrawal is critical during this transition period.
Brightworth provides investment management services to our clients using sound investment disciplines with customized, innovative planning. The core of this system, our Global Investment Solution, is a portfolio of carefully selected investments designed to enhance wealth while protecting capital over the long term. Through ongoing monitoring and evaluation, periodic tactical shifts, and flexible managers, we are able to take advantage of opportunities and manage risks in the near term for our clients.
While having a will and a plan for your assets after your demise is critically important, this is the #1 overlooked area we see with new clients. Perhaps you have a will but it’s twenty years old. Or you simply never got around to addressing your estate planning. Don’t be embarrassed by this. If you have a gap between jobs, use this time to meet with an estate planning lawyer to draw up a will or update your current estate plan.
Every adult needs at least a basic will, financial power of attorney, and healthcare power of attorney. If you have children age 18 or above, they also need these documents as they are legal adults. You don’t have the same rights to speak for them as you did when they were minors. Trusts are also a common estate planning technique our clients use to control and protect inheritance for their children or other family members.
While you may have set up beneficiaries for a variety of plans – 401(k), group life insurance, deferred compensation, and pension – we often see these designations not aligned with a person’s will or trust language. Its critical beneficiary designations are coordinated with your estate plan as these types of assets pass outside of your will. If you are leaving your company, your insurance and retirement plans are changing, paying out, or going away. This is a great reason to meet with an estate attorney to update your estate plan. In addition, there have been major recent changes to how retirement plans pass to children or other heirs that have large cashflow and income tax consequences. When tax laws change, it’s a great prompt to re-visit your will and trust documents.
Next, if you move to a new state for a new job, update the estate plan to meet the new state’s laws. Each state has its own set of rules and standard templates for power of attorney documents.
Can You Participate in the Gig Economy?
Many executives that have worked for a large company for decades may now want to consider leaving the corporate world. According to The Harvard Business Review’s “Thriving in the Gig Economy”, “approximately 150 million workers in North America and Western Europe have left the relatively stable confines of organizational life — sometimes by choice, sometimes not — to work as independent contractors.”
Some of this growth reflects the emergence of ride-hailing and task-oriented service platforms, but knowledge and skill-intensive industries, consulting jobs, and creative occupations are a fast-growing segment of the gig economy.
There are tax benefits and retirement planning strategies available for people considering work as a consultant or another position in the gig economy. To save taxes, you will be able to write off more expenses compared to corporate positions. Expenses such as mileage to job sites, cell phone and internet use, subscriptions, and vehicle costs may be deductible. While you’ll incur self-employment taxes (your employer paid 50 percent of this 15.3 percent on your behalf before), it doesn’t necessarily mean you’ll be paying more in tax for the same pay.
Next, there are more options for retirement savings. You may be able to sock away much more money before taxes into various retirement plans that include a Solo 401(k), SEP IRA, or defined benefit pension plan. Depending upon your income, this before-tax savings could easily be north of $50,000 annually. Working in corporate America, you may have been limited to half of that amount.
Finally, there are huge benefits for your personal freedom and independence. You can’t put a price on controlling your hours, being in total charge of your schedule or having unlimited vacation time. If you don’t need to work full-time to bridge your expenses to retirement, working in the gig economy can allow you to earn some income while testing out how you’d like to spend your time in retirement. Perhaps you start fitting in an hour or two walk each day, regular lunches with friends, driving carpool for children or grandchildren, or building that backyard living area you’ve dreamed about.
Understanding the “ins and outs” of your company’s compensation and benefits plans, including separation provisions, is important to make wise decisions with the options presented to you. Our team has helped numerous executives through the separation process due to a company merger or acquisition. We understand all of these details can be overwhelming at first, but rest assured, you do not need to figure this all out by yourself. Brightworth will develop a personal strategy for you to help ensure you are prepared to take full advantage of your separation or transition package, and most importantly, have a clear understanding of the impact on your overall financial well-being.
This information is based on information deemed to be factual and reliable. Please also refer to your company plan documents and your benefits department.