Executive Compensation

Executive Compensation Plans: A Summary of Terms

Golden Handcuffs

"Golden handcuffs" is a term referring to a collection of financial incentives that are intended to encourage valued employees to remain with a company for a stipulated period of time. Employers invest significant resources in the hiring, training, and retaining of key employees, and golden handcuffs, which are common in industries where highly compensated employees are likely to move from company to company, are intended to improve employee retention. In addition to the benefits listed below, other forms of golden handcuffs include contractual obligations that specify an action that an employee may or may not perform, such as a contract prohibiting a network television host from appearing on a competing channel, and supplemental executive retirement plans (SERPs) that are funded entirely by the employer.¹

Restricted Stock Unit

A restricted stock unit (RSU) is compensation issued by an employer to an employee in the form of company stock. RSUs are issued to an employee through a vesting plan and distribution schedule after the employee has achieved required performance milestones or has remained with the employer for a particular length of time. RSUs give an employee interest in company stock, but they have no tangible value until vesting is complete. The RSUs are assigned a fair market value when they vest. Upon vesting, they are considered income, and a portion of the shares is withheld to pay income taxes. The employee receives the remaining shares and can sell them at his or her discretion.²

RSUs can create a sudden increase in wealth that should be managed so that the wealth created can be maintained and managed against market volatility erosion. Managing risk involves a strategy that transitions from concentrated positions to balanced, diversified portfolios that can produce growth and income with reduced risk.

Nonqualified Deferred Compensation

A nonqualified deferred compensation (NQDC) plan allows a service provider (e.g., an employee) to earn wages, bonuses, or other compensation in one year but receive the earnings—and defer the income tax on them—in a later year. Doing this provides income in the future (often after the employee has left the workforce) and may reduce the tax payable on the income if the person is in a lower tax bracket when the deferred compensation is received.³

NQDCs, often referred to as 409A plans due to the section of the tax code they exist in, emerged in response to the cap on employee contributions to government-sponsored retirement savings plans. Because high-income earners were unable to contribute the same proportional amounts to their tax-deferred retirement savings as other earners, NQDCs were created as a way for high-income earners to defer the actual ownership of income and avoid income taxes on their earnings while enjoying tax-deferred investment growth.⁴

Qualified Plans

401(k) plans and traditional pension plans are two parts of the traditional three-legged stool of retirement: employer-provided pension, Social Security, and personal retirement savings. The biggest difference between a 401(k) plan and a traditional pension plan is the distinction between a defined-benefit plan and a defined-contribution plan.

Defined-benefit plans, such as pensions, guarantee a given amount of monthly income in retirement and place the investment and longevity risk on the plan provider. Defined-contribution plans, such as 401(k)s, place the investment and longevity risk on individual employees, asking them to choose their own retirement investments with no guaranteed minimum or maximum benefits. Employees assume the risk of both not investing well and outliving their savings.⁵

There are other differences as well, including the availability of each plan. Your employer is much more likely to offer a 401(k) plan than a pension plan in its benefits package. Pensions have become less common, and defined-contribution plans have had to pick up the slack, despite being designed as a supplement to traditional pensions rather than as a replacement.⁶ Roth 401(k)s allow for after-tax employee contributions to grow tax-deferred and tax-free distributions.