Executive compensation planning concerns corporate executives who may need to review Defined Benefit Plans, Non-qualified deferred compensation, employee stock options (either ISO, or NQSO), restricted stock, stock grants, diversification, liquidity, group life insurance, high income tax rates.

For example, an employee who needs executive compensation planning may have most of his investments in company stock and company stock options. There may be restrictions on selling the stock, if so then one should examine the need for a stock collar and/or alternative sources of liquidity for future emergencies. The need for diversification should be addressed.

Stock options may create both an AMT tax trap and the risk that paper wealth will be destroyed by a market crash, so it is important for key employees to get executive compensation planning.

Defined Benefit Plans for executives have hidden risk because if the company fails, a disproportionate loss may be shouldered by the top 25 executives (the Pension Guarantee Board only covers the first $54,000 (as of 2011) of annual pensions if retiring at age 65, less if retire earlier), and if one of them resigns and asks for a lump sum distribution from the Defined Benefit Plan the Custodian or Trustee may restrict the distribution until the rank and file workers have received their share of Defined Benefit Plan. Top officers of a company need to learn about executive compensation planning so as to be ready for this possibility. This restriction could be enforced even if the company has not failed.

Non-Qualified deferred compensation has interesting tax benefits, however they come with the risk that the employee may not be ab|e to retrieve the funds for many years and the funds are subject to the risk of the firm failing, so it should be viewed as making a unsecured loan to one’s employer. This would require doing an investment analysis of the employer to see if they are an “A to AAA” credit risk type of firm or are they are shaky firm with a “B-” credit rating? Also deferred comp could end up getting taxed at higher rates for payroll tax and for income tax when the funds are paid to the employee.

Stock grants as part of executive compensation planning are an interesting way to avoid the tax traps of options, however they also have tax risk and investment risk and liquidity risk.

The tax code allows employers to deduct the cost of financial planning fees paid on behalf of their employees as a fringe benefit, even if executive compensation planning was only a small part of the financial plan.

Special Report: Hidden Risks of Non-Qualified Deferred Compensation

Donald Martin is a NAPFA-Registered Fee-Only financial planner and investment advisor.