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How To Make A Cash Flow Plan When You Have Executive Compensation Thumbnail

How To Make A Cash Flow Plan When You Have Executive Compensation

As an executive, a significant part of your total income is likely tied to company performance through bonuses and one or more forms of equity. 

The good news, of course, is that these arrangements can be lucrative and may potentially yield a considerable amount of money. However, having so much of your net worth in illiquid assets does mean you’ll need to be more deliberate with cash-flow planning.

When you receive non-salary compensation, your cash flow is less consistent. Because your compensation isn't just cut and dry paychecks, you need to plan for both spending, saving, and tax-efficient "to do's" when you receive other forms of compensation like bonuses, stock, or options. 

Determine Your Cash Flow Sources

First thing's first, ask yourself,

Where does your cash flow come from? 

As you would with any budget or cash-flow plan, gather the information you’ll need before you begin thinking about what you’ll do. Examples include:

  • Base pay
  • Stock, like RSUs, ESPPs, etc.
  • Options, like ISOs, NSOs, etc.
  • Bonuses

Start by looking over the past year (or two) to estimate how much income you can anticipate, and when it comes, i.e., bi-weekly, monthly, annually, etc. While you may get your paycheck every other week, you typically only get a bonus annually, and most of it is likely in the form of equity. If you are new in your position or your non-cash compensation has recently changed, don’t forget to think about what additional sources may be coming as well.

Listing everything out is helpful, so you’ll know when cash flow is coming, but it’s also critical as it highlights when cash flow isn’t coming—you can’t use your constant trickle of ISOs to pay the cable bill. Most people plan their personal budgets monthly, but if your cash flow doesn’t flow evenly throughout the year, that cadence may not work for you.

Cash Flow Structure

Next, consider how your cash flow comes. What type of cash flow is happening? Is it direct salary compensation, bonuses, or equity? Make sure you account for everything, including when a stock grant might vest. 

Keeping track of your stock’s vesting schedules can get complex since many will operate on different time frames. For example, you may have one set of ISOs vest in a year, but the ones you received as a bonus have a 5-year vesting period. 

Some income, namely your salary and bonuses, will result in “automatic” cash flow meaning there’s nothing you have to do for that cash to end up in your pocket. Other forms of compensation may or may not result in immediate cash flow and require you to make a decision that converts it into cash.

For example, you could have significant compensation value in the form of stock options. Until you exercise the options and sell, the resulting shares don’t appear in your cash flow. 

Remember, exercising your options and selling the shares are two distinct events. It’s also challenging to know the exact value of your compensation until you actually exercise or sell because you don’t know what the stock's market price will be in advance—there’s no crystal ball! Because of this, it’s helpful to plan within a range, usually plus or minus 25% of the current stock price.

A range gives us options when planning how to allocate the funds. If, for example, there was a significant swing in your company’s stock price, we may need to reduce the amount you contribute to a 529 that month or hold off on the extravagant trip until the markets are better. 

Planning within a range becomes especially critical when you need the funds from your equity compensation to help cover more routine expenses. 

Taking a compensation range into account is an essential consideration for your budget and provides a planning opportunity to ensure you maximize the total value of your compensation.

Plan for Taxes 

It’s vital to understand how the various components of your compensation are taxed. As with cash flow, some forms of compensation will create an automatic tax liability for you, while taxation on other forms may depend on what you do.

For example, when restricted stock units (RSUs) vest, it’s as though you receive a paycheck. You incur an income tax obligation on the value of the shares as of the day you receive them, regardless of when or if you actually sell the shares. You still have to decide what you’ll do with the shares, and the ability to pay the taxes should be a factor in that decision.

If you know you'll have a "big splash" during vesting season in February or March, plan to address taxation on vested shares. Make sure you have sufficient cash on hand that you can set aside for taxes or block time to sell enough shares of other investments to raise the needed cash.

If your compensation includes stock options, you only incur a tax liability when you act on them. Again, the type matters. Nonqualified stock options (NSOs) are taxed when you exercise them, even if you don’t sell the shares. You’ll be taxed on the difference between the price you pay and the market value. Incentive stock options (ISOs) have more complicated tax consequences that should be carefully considered before moving forward with either exercising and/or selling shares. 

A key takeaway is that when you receive non-salary compensation, both cash flow and tax planning become even more vital and must be considered jointly.

Plan for Your Goals and Lifestyle 

Once you’ve made a plan for your cash flow and corresponding taxes, you can align those factors with the things going on in your life. 

If you know when you can expect larger bonuses or equity compensation, plan your goals around those times! Perhaps you’ll allocate some of your bonus toward a delayed honeymoon trip, use it to max out a retirement vehicle, or even pay off some debt. 

Say you have a goal to make a significant contribution to your child’s 529 plan; schedule the deposit around when you know you'll get an influx of cash compensation. Or, if you know you want to go on a large family vacation, plan it for after you address your vested equity compensation.

You don’t want to spend money that’s not there, so check in with your cash flow and projected tax bill. By waiting until after you know these two variables, you’ll have a clearer sense of how much "extra" cash is left to spend on travel, home upgrades, additional investments, etc.

And finally, make sure you speak with your advisor! All compensation isn’t the same regarding cash flow and taxation. The number one thing you can do to maximize the value of your compensation is to understand your payment "flow" and plan ahead to address taxes efficiently.

We’d love to help you manage your cash flow and use it in smart, tax-efficient ways that help you reach your financial goals. Set up a call with our team to learn more today.