Tackling One of the Biggest Questions in Personal Finance
In this post I wanted to touch on one of the biggest questions in personal finance – how to transition to retirement. Specifically, as it applies to the world of equity compensation.
I’m giving some official disclaimers right up front.
First, this is almost never a simple decision. Even if you win the lottery there are lots of small decisions that need to be made before you can make the big one of transitioning to retirement. At least I’m guessing so since I’ve never won the lottery, despite buying tickets every so often. I know the odds are against me, but I still do it.
Next, and this is an extension of the first decision, and is a rather personal decision. There is no uniform rule that if you have saved X amount of money at Y age you can now retire. Please ignore the general advice you see in the media along these lines. It is more complex because there are considerations such as maybe you have enough money saved, but mentally you are not ready to golf or fish every single day. Those articles never seem to mention things other than how much you have saved by a certain age.
Finally, and to repeat myself – this is an extremely complex decision. You’ve worked, saved, and lived for decades. It takes time to unwind everything you have been doing all these years. Compare the transition to retirement to the process of losing weight. You didn’t gain an extra 30 pounds overnight. It will take some amount of time to shed those pounds, just like it did to gain them. My point is to properly transition to retirement it will take time. Not as long as you spent working, but it will take some time to do it correctly and on your terms.
Side note here. According to the financial media, transitioning to retirement is as simple as just giving your notice one day, followed by a party and some cake. They view it through a very idealized and simplistic lens. In reality, transitioning to retirement take time and lots of boring work behind the scenes with your CFP®.
The Basics of the Retirement Transition
Okay, let’s focus on some of the basics. Some of the bigger brains in this world break down retirement planning with equity compensation into multiple phases. I agree with this concept. Because it is so involved we will not be able to cover the entirety here. However, let’s cover some of the most important concepts of the transition to retirement phase.
First, take stock of your equity compensation NOW. I promise I was not going for a pun there. I seriously want you to take inventory of your various equity compensation positions. I don’t care if you are 64 or 34. Take the time to gather up the details on your Nonqualified Stock Options, Restricted Stock Units, Restricted Stock Awards, and also your Employee Stock Purchase Plan positions. Let’s look at some of the details you should gather in the cases of Nonqualified Stock Options and RSUs:
- Nonqualified Stock Options:
- Grant Date
- Expiration Date
- Grant Price
- Vesting Status
- Restricted Stock Units:
- Grant Date
- Vesting Date
- Distribution Date
- If it has already vested and you still hold it, the cost basis details
Step two is to add up the value of your current equity compensation positions, both current and once fully vested. You also need to add up the value of your non-equity compensation holdings that are designed for your retirement. From here you can determine what percentage of your overall “retirement holdings” are in one stock. Now we get to see what type of Concentration Risk you are dealing with. And if you need a refresher on Concentration Risk, see this previous article I wrote on Misconceptions of Concentration Risk.
The Third Step
The third step is to gather up the legal documents related to your equity compensation. Your employer would have provided you with documents that lay out all the rules and requirements for your Options, Restricted Stock Units and Awards, and also your Employee Stock Purchase Plans. Treat these documents like any other important legal document, such as your will, healthcare directives, etc. And I do not mean throw them in a box in the attic where they will just gather dust, but whatever safe and secure location you prefer such as a fireproof safe.
Fourth Step (or Maybe Step 3.5)
The next step is closely tied to the previous one, but I’m still calling it the fourth step. It is to review these documents to learn what happens with any unvested and unexercised positions when you retire. Such as, do you have to exercise them within 10 days or maybe you lose any unvested RSUs. It is also important to determine if the rules change in cases of an early retirement. Finally, what happens to those positions if you pass away while still working? All of these are questions that need answers, which can be found in the plan documents. And if not, do not be shy in regards to reaching out to the equity compensation specialists at your job.
Step 5 – The Final One (For Now)
The fifth and final step we will cover today is to develop a plan around each stock option when it is granted to you. Now that you’ve spent all the time gathering up the details on your entire retirement picture, you can start deciding if and when you should start exercising options. Factors going into this decision include years to retirement, Concentration Risk, taxes, total retirement savings, and also vesting schedules for Restricted Stock Awards and RSUs. While you cannot control when RSUs and Awards will vest and create a taxable event, you have more control over this with stock options.
For example, let’s say your investment plan is to never have more than 40% of your retirement savings in one stock. You project out the vesting of future RSUs in the next five years will take you over that 40% number. While you cannot stop their vesting (unless you leave), you may be able to exercise and then immediately sell some stock options. In these cases your tax bill may be a bit higher, but the more important factor is to avoid a concentration risk above your tolerance level. This is a personal decision you have to make – is it more important to keep your concentrated stock below a certain level or keep taxes as low as possible (I bet you have never seen a mass media article talking about this level of specificity in a “transition to retirement” article).
Okay, this is a good point to stop. I’m sure I’ve given you enough to get the brain going and I imagine your homework list is rather lengthy at this point. Please do not be overwhelmed. Equity compensation is an incredibly valuable benefit most employees are not able to enjoy. Take the same approach to your homework as you would if you were eating an elephant – one bit at a time over a long period of time. It has taken you years to accumulate these holdings. It is only fair to give yourself lots of time to get everything organized and in order. That is why it is called planning for the transition to retirement.
Flashbacks – Best Summer Job, EVER!!!
Since most of my clients are GenX and Baby Boomers, I figured I would start adding a flashback section. Hopefully these memories are interesting to more than just myself.
And because we’re talking about transitioning to retirement, I figured I would talk about the best summer job I ever had. Now, I have been working since I was 12 or 13 (paper route with the Akron Beacon Journal). One summer I decided to try and get hired at Cedar Point. It was a great decision.
The idea first came up with a couple of my freshman year roommates. The three of us and another guy down the hall saw the ads on campus to work there. We happened to have two guys on our floor who worked there the summer before and they gave us the rundown. It sounded great.
The big key they gave was to be outgoing in your interview. Now, I am a huge introvert so this was tough for me. The other three guys were all out going so it was easy for them. Two of them were offered jobs working games. Their personalities matched the barking carny approach Cedar Point wanted for games workers. The third guy decided not to work there after his interview and offer. I was given rides as my offer. Specifically, White Water Landing, which was a water ride (I bet you figured that out already) and I was pumped!
The deal was to report to Cedar Point pretty much right after spring semester ended. And because we were close, we had to work the bonus weekends. At that time they ran just through September.
So, I reported to Cedar Point two days after the end of exams and moved into a cruddy “dorm” with the two guys from my floor, both named Todd. If you are familiar with Cedar Point, we lived in the red building you could see from the main station of the train.
When I arrived I found out my position on White Water Landing was not available. Apparently, Cedar Point over-hired every year because lots of people would just not show up. That summer everyone showed up. They then moved me to work on the Junior Gemini. Yes, I ended up working kiddie rides. It was a bit annoying, but then I realized it was me and 13 girls. Not a bad tradeoff.
I spent a few weeks working on the Junior Gemini and then my area supervisor asked me if I wanted to transfer to the train. I figured it was worth it as there were more hours (more money) and I no longer would have to deal with teenagers trying to ride a kiddie roller coaster (At least twice a shift I had a “clever” teen trying to tell me he was young enough to ride).
I then shifted over to the train where I became a fireman. This simply meant I threw coal into the fire to keep the steam going. I quickly learned this was more complex than pushing a button to start the Junior Gemini.
That’s enough for now. I promise to share more stories about the best summer job ever.
As always, thanks for taking the time to read this. Please do not hesitate to reach out if I can be of help with your equity compensation-related questions. The easiest thing to do is to click the little green box that reads “Schedule a Meeting” that can be found at the bottom of every page on my website. Or, just click my Calendly link right here.
I’m Dan Johnson, CFP®, founder of Forward Thinking Wealth Management. I run a flat-fee financial planning and investment management firm located in beautiful Akron, OH. Although I am in Akron, OH, I work with clients regardless of location. I cater to owners of equity compensation positions who are looking to organize their financial lives, keep more of what they make, and do the things they want in retirement and even now.