Having a robust employee benefits package is a great way to attract and retain quality talent. In fact, some younger companies are adding perks like free financial advice, unlimited PTO, free food and even pet insurance to entice the best prospects. However, it’s wise to consider all the costs of employee benefits and if they’re feasible for your company. Some benefits like stock awards can be very complex and need to be established properly to avoid legal or financial repercussions. Also, many startups are tempted to spend money on excessive perks like massages, when those funds should be reinvested into the business instead.
Besides direct monetary compensation, employees receive another compensation package that is just as valuable; a benefits package. Yes, an employee benefits package consists of medical, dental, and vision insurance along with other benefits like Paid Time Off or PTO.
A benefit plan also includes a standard retirement plan like a 401(k), 403(b) or SIMPLE IRA depending on the business’s size and industry. For example, some small businesses can’t afford the pricing and complexities of a 401(k), making a SIMPLE IRA a better choice. Other businesses that only offer 403(b) plans are non-profits and/or associated with the government.
In addition to standard retirement plans, companies offer stock or equity awards for some high performing employees. These awards are company shares which make the receiving employee a partial owner of the firm. By doing this, an employee’s interest will be more aligned with the company’s best interest. If the stock price increases, the value of an employee’s stock awards will increase as well. There are many types of stock awards, but the most common types are Non-Qualified Stock Options, Incentive Stock Options, and Restricted Stock Units. Each award type has a different tax treatment and vesting schedule.
As a small business owner, you likely wear many hats and juggle different tasks. However, it would be well advised to delegate employee benefits to qualified employees and/or a third party. This is because many employee benefit plans are complex and are required to be compliant with many laws. For example, retirement planning is a highly regulated, tricky part of this process and is subject to many laws like ERISA. ERISA is an intricate set of laws meant to protect employees’ retirement savings from unscrupulous investment advisors and employees.
One important ERISA requirement states that investment advisors that manage the plan must be fiduciaries, or an act in an employee’s best interest. If employees seek advice from a financial adviser regarding their retirement plan, that adviser is considered a fiduciary as well.
There are three main ways to remain compliant with ERISA. The three main ways to accomplish this are reporting, disclosure, and paying claims.
There are a variety of employee benefit plans, and high-income earners have some of the most unique ones. For instance, many highly paid employees and C level executives have plans like 457(b)s and deferred compensation plans. Since these employees can make hundreds of thousands of dollars annually, they usually max out their 401(k)s early in the year. These plans allow highly paid employees to save for retirement on a tax deferred basis.
It’s important to note these plans are very different from a standard 401(k) or 403(b). For example, 401(k)s and 403(b)s are protected by ERISA while deferred comp plans are not. This means that the person who invests in a deferred comp plan is considered to be a general creditor of the company. If the company fails, the highly compensated employee could lose their deferred compensation funds. Conversely, this would never happen to funds in ERISA protected 401(k)s/403(b)s.
As mentioned earlier, stock awards are becoming very popular especially in the high growth tech industry. It’s not uncommon for an executive to have a relatively small base salary of $200K and have their total annual compensation jump to over $1,000,000 when considering their stock awards. The most common types of these awards are Non-Qualified Stock Options, NQSOs, and Restricted Stock Units, RSUs.
How Do NQSOs Work?
A NQSO has a strike price and individuals would want the current stock price to rise above it. For example, you receive 100 shares of NQSO company stock with a strike price of $10. If the stock price rises to $15 and you exercise or sell your shares, you’d profit $500 ($15-$10 at 100). If the stock price is below the strike price, you wouldn’t want to exercise these options as they’re worthless or underwater. NQSOs are taxed when you exercise your shares. These options can be taxed at favorable, lower capital gains rates if you sell your options after a year of holding them. Conversely, you’d be taxed at higher ordinary rates based on your tax bracket if you sell before holding them for a year.
How Do RSUs Work?
RSUs are very different and more popular than NQSOs. For instance, RSUs don’t have a spread or strike price. Instead, RSUs are transferred to cash when they vest. Vesting means that you would receive these options and they would be taxable in the same year. Like NQSOs, your employer would put stock award proceeds on your W-2 the year you sell them.
RSUs are generally granted in a relatively large quantity like 9,000 shares. From there, they would typically vest over a 3-year period and you would receive 3,000 shares per year. This is a common vesting schedule, although some companies have vesting schedules over 10 years, while others have monthly schedules.
Stock or Equity awards are very intricate and can greatly impact an employer’s or an employee’s taxes. Therefore, it makes sense to plan for any possible exercises and the current condition of the company.
Employee benefits are an important part of an employee’s compensation. Retirement plans, stock awards, health care plans, and PTO are common parts of a typical plan. It’s not recommended to try to manage all these components by yourself. Therefore, you should delegate the right people to manage these plans, including legal counsel. Pension Lawyers uses our decades of experience to help you: