12 Sep The three mistakes executives make with their employee share plans
Over the years, I have worked with many executives in public companies who earn a large portion of their income by way of share bonus plans. For those lucky enough to have this opportunity, it is a fantastic way to accelerate your path to financial freedom. But there are some pitfalls. These are the three most common mistakes I have come across.
- Failing to plan for tax bills
As Benjamin Franklin said, there are only two things certain in life; death and taxes. For your month to month salary, the employer deducts tax under the PAYG system to avoid nasty tax surprises at the end of the year. However, no tax is deducted when share plans are issued which means the tax is assessed and payable when you lodge your tax return. This could be up to 18 months after you have received your shares and you might have forgotten all about it!
For example, say you receive $100,000 worth of ABC shares in August 2017 and are on the top tax rate (49%). Assuming you use an Accountant, you may not need to lodge your 2017/18 tax return until March 2018 and only then, you will receive your tax bill of $49,000. That is a long lead time and those shares may have been sold and (at best) been used to pay down your home loan or (at worst) funded a first class round the world ticket for your 20th wedding anniversary. Come to think of it, there may be worse ways to spend your money, but you see where I am coming from!
There is also potentially another whammy here because the ATO will assume that you will be allocated a similar portion of shares for the next year and tax you in advance under the PAYG system. But I’ll expand on this in my next article.
- Failing to diversify
Most executives are optimistic about the long term prospects for their company which they expect will mean rising dividend share price appreciation. And overall, this is a good thing – why would you want to work so hard for a company that is going nowhere?
But there can be potholes. The staff at Enron had most of their remuneration and their superannuation tied up in company shares and we all know how that ended! Of course this is an extreme case but when you are really close, it can be difficult to see external factors which may impact the company and it is almost impossible to anticipate how the sharemarket will react to bad news.
Compounding this risk is the method of tax assessment. You will be assessed for income tax on the value of the share when they become available to you and if the shares fall in value subsequently, that is your problem (not the ATOs). In the example above, say you retained the $100,000 of shares and they subsequently fell to $75,000 in value. You would still have to pay the tax of $49,000. A lot of executives got caught out with this in the GFC.
So my advice is that you sell some shares over time and diversify, either into other shares or other asset classes (eg. international shares, bonds, property etc).
- Forgetting about your spouse
Even if you did go on a round the world trip with your spouse, you may not have thought about transferring the shares (which you want to retain in the family unit). Your spouse may be on a lower tax rate than you and the strategy could reduce the income tax you pay on the dividends and the subsequent capital gains which accrue after you have transferred them. So don’t forget your spouse!
Finally, tread carefully! This is a complex space and it is worthwhile getting advice. If you want to have a general chat about your share plan, email me at firstname.lastname@example.org or drop me a line on 9211 0175.
DISCLAIMER: The information in this commentary has been provided for publication Adapt Wealth Management (ABN 76 821 231 362 Corporate Authorised Representative of Paragem Pty Ltd AFSL 297276). No Liability is accepted by Adapt Wealth Management Pty Ltd, its Directors, officers, employees or contractors for any inaccurate or incorrect information. The information is a broad commentary and there is no intention that a client should act on the information without seeking professional assistance from their own advisers (legal, tax, accounting, financial planning) for suitability in respect of their unique circumstances.
About Reuben Zelwer
Reuben Zelwer established Adapt Wealth Management in 2011 to help time poor clients achieve financial freedom. For over 15 years, Reuben has helped professionals, executives, business owner and those approaching retirement make the most of their circumstances by making good financial decisions. Reuben’s professional practice is complemented by substantial voluntary work, which has included setting up financial literacy and savings programs in the local community.