By Chuck Steege. Stock options have been granted to executives at a regional airline for many years. After losing two senior executives to competitors recently, the airline’s board decided to award performance shares in order to provide current year income on vested shares through dividend equivalents.
Dividend equivalents are payments of cash or additional company stock an executive receives after the units vest. While stock options do not pay dividends, dividend equivalents can offer executives the flexibility to increase or supplement their income. This example explains the benefits and how they work.
Nick*, manager of internal audit for the airline, is craving an ocean adventure that’s bound to give him a sense of freedom and accomplishment. He wants to strategically use the income from his Performance Stock Units (PSUs) to provide supplementary cash flow for what will be an unforgettable trip.
With his three children grown, he’s finally in a place personally and financially to take a month sailing to tackle the Newport Bermuda race, a 635-mile race from Newport, Rhode Island to Bermuda.
Nick has 10,000 PSUs. The company’s fiscal year ends on Sept. 30, 2016, and his PSUs are expected to vest on Oct. 31, 2016 as long as all the performance requirements are satisfied, which means the company’s efficiency metrics must be good.
Nick will receive his accrued dividend equivalents after the units vest. Dividend equivalents may be deferred for release for up to two and a half months, subject to company policy.
His financial advisor suggested Nick consider deferring his dividend equivalent income until January 2017, so they will be subject to ordinary income tax in that year, when his overall tax rate will be much lower. Nick’s dividend equivalents are subject to Social Security taxes as they vest. This plan will ensure that the extra income flows in shortly before his trip. The 55 year-old executive wants to make sure his trip doesn’t cause cash flow problems for his family or drain his retirement savings. While he may retire from the company at year’s end, he expects to ultimately retire when he turns 60.
Working with an advisor who understands the plan document, tax and planning implications made the difference in Nick feeling confident that his dream trip would not imperil his 2017 income or his family’s long-term financial strategy.
*The name, likeness and circumstances in this example are a fictional composite of facts from executives similar to actual SFG Clients.