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This Time It's Personal

Retirement planning isn't easy, which is why so many executives put it off.
Scott Leibs, CFO Magazine
June 1, 2006

This year, demographers tell us, the massive wave of baby-boomer retirements will begin, and the impact will be felt on everything from corporate-succession planning to condo sales. One likely ripple effect will be a mad rush to the offices of financial planners, as executives who spent a lifetime accumulating wealth hastily devise strategies for tapping it.

Advisers say procrastination is the norm, for many reasons. During a person's peak earnings years, and with a proper asset-allocation plan in place, there may be little to do but sit back and watch the money pile up. But the transition from sitting on that nest egg to cracking it open can be wrenching. It requires you to take a hard look at your mortality and prioritize goals that may range from travel and vacation homes to providing financial assistance or a legacy to loved ones. For some, simply maintaining a decent standard of living for decades beyond retirement age, with health and vitality an open question at every stage, will be a challenge. Given all that, it's no wonder the unexamined portfolio seems most worth having.

As C-level executives approach retirement, however, advance planning is essential. That's because, as U.S. Trust managing director Mitchell Drossman notes, "senior executives typically have most of their wealth tied up within the four walls of their companies, in the form of deferred compensation, stock options, restricted stock grants, and related vehicles." Senior executives and, in particular, "proxy people," as Drossman terms them (because their positions and compensation are significant enough to be outlined in their firms' proxy statements), should begin actively planning their retirement two to five years before they intend to leave. During that time, they will essentially transition from highly compensated employees to more traditional (that is, diversified and reasonably liquid) investors.

They may also enter retirement as more sober investors. "Executives are often guilty of overconfidence," says Susan Hirshman, managing director and wealth strategist at JPMorgan Asset Management. "Studies have found that executives tend to repeatedly overestimate the actual performance of their company stock and of their own portfolios. Once they sit down [to plan], they may find that they aren't doing as well as they thought they were" (see "Falling Short" at the end of this article).

"CFOs tend to enter retirement with very concentrated stock positions," agrees Ellen Rinaldi, a principal at Vanguard Group's advice brokerage and retirement-services group. They may have accumulated shares, grants, and options at just one or two companies over many years, she says, and often feel a sense of loyalty that prevents them from diversifying as broadly and as early as they should. Drossman says it's not unusual for a proxy person to possess 10 years' worth of equity-grant letters, each one laying out a variety of stock options, restricted stock, and other goodies that generally can be classified under federal tax laws as either nonqualified or incentive. "That amounts to 20 tranches of retirement funding," he says, "built around a carrot-and-stick approach to personal and corporate performance. You need to look at those grant letters carefully, review the terms of your company's equity compensation plan document, and devise a plan, or you get whacked."

Taxes are, of course, a major source of such whacking. Tax treatments will vary for nonqualified versus incentive options. Exercising a nonqualified option is a taxable-compensation event and will leave you paying tax on the gain at ordinary income rates, which run as high as 35 percent, plus FICA taxes.

Incentive (or "qualified") options, in contrast, are not considered a taxable event when exercised (although they do call for an adjustment when calculating the alternative minimum tax), and the difference between the exercise price and the price of the newly acquired stock when ultimately sold is taxed at the 15 percent capital-gains rate, assuming you've held the shares for a year from exercise and two years from the date of grant. But even so-called incentive stock options that are not exercised within three months of retirement must then be treated as nonqualified options for tax purposes, which could take a bigger bite out of the gains — a big reason why anticipating your retirement is key to financing it.

That's just one example of the complexities that await those retiring with portfolios that consist of far more than an IRA and a fervent hope that Social Security doesn't collapse. The first bit of advice from advisers, of course, is to hire an adviser, and in this case they're probably right. Conventional wisdom holds that you tap taxable assets first and let tax-deferred accounts such as IRAs and 401(k)s continue to grow, ultimately reaching into them in this order: annuities, IRAs, employer 401(k) accounts, Roth IRAs, and Roth 401(k)s (unlikely to apply to near-retirees since they just went into effect this year). Within each class, tap the more expensive first, so that you draw down an IRA with a higher expense ratio earlier and allow a less costly one, such as a stock index fund, to continue to (one hopes) build.

But that boilerplate advice can't take into account the many personal goals, obligations, and predilections of any given retiree. While retirees will have plenty of decisions to make, and paperwork to consolidate, even a seasoned finance pro should get outside help. Just as a trial defendant who represents himself is said to have a fool for a lawyer, so, too, in most cases, does a high-net-worth individual who takes a do-it-yourself approach to retirement planning risk an unhappy outcome.

Scott Leibs is a senior editor at CFO.

Falling Short

While C-level executives tend to be high-net-worth individuals, and would thus seem to face rosy retirements, they aren't immune to a common misperception: that their nest eggs are larger than in fact they are.

A 2005 survey (by the MainStay Investments unit of New York Life Investment Management LLC) of more than 1,200 middle- and high-net-worth Americans, some in retirement and others approaching it, found a consistent gap between how much money respondents expected to have in retirement and how much they were likely to have based on their current savings regimens and existing assets.

Optimistic assumptions about their amount of home equity, anticipated inheritances, and their ability to "catch up" on retirement savings in the final years of their working lives emerged as reasons for the overconfidence. Also playing a role was anticipated life expectancy. While people generally expect to live longer, few realize that for a healthy couple in their 60s, there is a 50 percent chance that at least one member will live to 92 or beyond. That presents a longer time horizon than most people plan for. Even among people who have been retired for five years or more, fewer than one in four attempt to match savings to that kind of longevity. — S.L.

Preretirees 1–5 years in retirement 5+ years in retirement
Projected savings $1.58 million $1.22 million $1.31 million
Likely savings $988,400 $758,200 $808,600
Projected income* $7,100 $5,600 $5,400
Likely income* $4,700 $4,300 $4,300
Current income* N/A $4,200 $4,900
*Monthly, in retirement
Source: 2005 MainStay Investments survey of 1,200 people aged 50–90 with at least $100,000 in assets.

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