$340,000 Tax Savings: Optimizing Team Compensation Structure

$340,000 Tax Savings: Optimizing Team Compensation Structure

Executive Summary

Harrington Legacy Advisors, a growing RIA firm, faced significant tax inefficiencies within their existing team compensation structure. Their reliance on traditional salary and bonus models resulted in high tax burdens for both the firm and its employees. By partnering with Golden Door Asset, Harrington Legacy Advisors implemented a redesigned compensation plan incorporating deferred compensation and strategic equity options, resulting in an estimated $340,000 in tax savings for the team in the first year and aligning team incentives with the firm's long-term growth objectives.

The Challenge

Harrington Legacy Advisors (HLA), a thriving RIA managing over $500 million in AUM, recognized their compensation strategy was hindering their ability to attract and retain top talent while simultaneously minimizing tax liabilities. Their existing compensation model primarily consisted of base salaries and annual bonuses, heavily weighted towards cash compensation. This traditional approach presented several key challenges:

• High Tax Burden: Employees were subject to substantial income tax and payroll tax liabilities on their bonuses, significantly reducing their take-home pay. For example, a $50,000 bonus could easily shrink to $30,000 or less after taxes, leading to dissatisfaction despite strong performance.
• Limited Incentive for Long-Term Growth: The bonus structure primarily incentivized short-term performance, focusing on immediate revenue generation rather than the long-term health and growth of the firm. There was little alignment between individual employee performance and the overall firm valuation. The firm desired an incentive structure tied to the 5-year growth plan.
• Inefficient Use of Firm Capital: The firm was disbursing large sums of cash in the form of bonuses, which could have been reinvested into the business for strategic growth initiatives, technology upgrades, or marketing campaigns. HLA estimated they were allocating 15% of gross revenue to compensation expenses annually and sought to optimize this allocation for better returns.
• Recruiting Disadvantage: As other RIA firms began offering more sophisticated compensation packages that included equity and deferred compensation, HLA risked losing out on top candidates who were seeking tax-advantaged compensation opportunities. They found that prospective hires were turning down offers representing a 10% increase in base salary due to the lower tax benefits.
• Lack of Retirement Planning Component: While HLA offered a 401(k), the existing compensation structure didn't actively encourage employees to prioritize long-term retirement savings, a key benefit valued by employees, especially in the financial services industry.

These challenges led HLA to seek a comprehensive solution that would reduce the tax burden on both the firm and its employees, better align employee incentives with long-term firm growth, and enhance the firm's ability to attract and retain top talent. They needed a strategy that converted current fixed cost liabilities to growth-linked incentives.

The Approach

Golden Door Asset collaborated closely with Harrington Legacy Advisors to design a tailored compensation plan that addressed their specific challenges and objectives. Our approach involved the following key steps:

1. Comprehensive Needs Assessment: We conducted in-depth interviews with HLA’s leadership team and key employees to understand their current compensation structure, performance metrics, and long-term goals. We analyzed their financial statements to identify areas of tax inefficiency and opportunities for improvement. This included a full audit of the current payroll and benefits expenditures.

2. Strategic Compensation Design: Based on the needs assessment, we developed a multi-faceted compensation plan incorporating the following key elements:

   • Deferred Compensation Plan: A significant portion of employee bonuses was allocated to a non-qualified deferred compensation (NQDC) plan. This allowed employees to defer income and the associated tax liability to a future date, typically retirement. This strategy provides significant tax advantages, especially for high-income earners. The structure was designed with a vesting schedule of 3-5 years, matching the firms overall strategic objectives.
   • Equity Options: A portion of the compensation package included stock options in the RIA firm. This gave employees a stake in the firm's long-term success and incentivized them to contribute to its growth and profitability. The options were structured with a vesting schedule tied to specific performance milestones and firm valuation increases. Golden Door developed a performance prediction model to calculate the probability of the firm reaching the vesting milestones, which in turn helped calculate the tax implications of the stock options.
   • Performance-Based Bonuses: While the focus shifted away from traditional cash bonuses, a smaller portion of compensation remained tied to individual performance metrics. However, these bonuses were now tied to specific, measurable, achievable, relevant, and time-bound (SMART) goals aligned with the firm's overall strategic objectives. This portion was designed to be a smaller, incremental bonus, with a percentage cap placed on overall firm profit margin.
   • Enhanced Retirement Savings Plan: We worked with HLA to enhance their existing 401(k) plan by increasing the employer matching contribution and providing employees with financial planning resources to help them maximize their retirement savings.

3. Tax Planning and Modeling: We utilized specialized tax planning software to model various compensation scenarios and project the potential tax savings for both the firm and its employees. This allowed us to optimize the allocation of compensation between salary, deferred compensation, equity options, and bonuses to maximize tax efficiency. This tax planning module incorporated relevant federal and state tax codes and accounted for potential changes in tax laws.

4. Communication and Education: We developed a comprehensive communication plan to explain the new compensation structure to employees and address any questions or concerns they may have. We also provided employees with financial education resources to help them understand the benefits of deferred compensation and equity ownership.

5. Implementation and Integration: We worked closely with HLA's payroll department to seamlessly integrate the new compensation plan into their existing payroll system. This included configuring the payroll system to properly track deferred compensation and equity options, as well as generating the necessary tax reporting forms.

Technical Implementation

The successful implementation of Harrington Legacy Advisors' optimized compensation structure relied on precise execution, leveraging specific financial tools, methodologies, and integrations. Here's a breakdown:

• Scenario Modeling with Tax Planning Software (CCH ProSystem fx Tax): We used CCH ProSystem fx Tax, a leading tax compliance and planning software, to model the tax implications of various compensation scenarios. This involved inputting employee salary data, bonus amounts, deferred compensation elections, and equity option grants. The software then projected the federal, state, and local tax liabilities for both the employees and the firm under each scenario. This granular analysis allowed us to identify the most tax-efficient compensation mix.
• Deferred Compensation Tracking and Management: We used specialized deferred compensation administration software (e.g., an ADP module) to track employee deferral elections, calculate accrued benefits, and manage the distribution of deferred compensation payments. This software ensured compliance with all applicable regulations, including IRS Section 409A. The system was configured to automatically withhold applicable taxes and generate the necessary tax reporting forms (e.g., Form 1099-MISC).
• Equity Option Administration Platform (Carta): To manage the equity options granted to employees, we implemented Carta, a leading equity management platform. Carta provided a centralized system for tracking option grants, vesting schedules, and exercises. Employees could log in to the platform to view their equity holdings and track the value of their options. The platform also integrated with HLA's cap table and financial reporting system.
• Payroll System Integration (Paychex): We integrated the deferred compensation and equity option data from the administration platforms with HLA's payroll system (Paychex) to ensure accurate tax withholding and reporting. This integration automated the process of deducting deferred compensation contributions from employee paychecks and reporting the value of exercised equity options on W-2 forms.
• Financial Modeling for Firm Valuation: We employed discounted cash flow (DCF) analysis to determine the fair market value of HLA's equity for the purpose of granting equity options. This involved projecting the firm's future revenues, expenses, and cash flows and discounting them back to their present value using an appropriate discount rate. The DCF model was updated annually to reflect the firm's performance and market conditions. This model also incorporates the potential impact of future acquisitions, as well as economic indicators used for financial forecasting.
• Compliance Monitoring: We established ongoing compliance monitoring procedures to ensure that the compensation plan continued to comply with all applicable regulations. This involved regularly reviewing the plan's terms and provisions, monitoring changes in tax laws, and consulting with legal counsel.

Results & ROI

The implementation of the optimized compensation structure delivered significant financial benefits to both Harrington Legacy Advisors and its employees:

• $340,000 in Tax Savings: The revised compensation structure resulted in an estimated $340,000 in tax savings for the team in the first year alone. This was primarily due to the deferral of income into the NQDC plan and the tax-advantaged treatment of equity options. This figure accounts for federal, state, and local tax reductions.
• Increased Employee Retention: Employee retention rates increased by 15% in the first year following the implementation of the new compensation plan. This was attributed to the improved tax benefits and the increased sense of ownership among employees. This also correlated to a reduction in recruiting costs which were down 20% year-over-year.
• Improved Employee Engagement: Employee engagement scores, as measured by annual surveys, increased by 20% after the implementation of the new compensation plan. This was attributed to the increased alignment of employee incentives with the firm's long-term growth objectives.
• Enhanced Recruitment: The new compensation package became a significant recruiting advantage, allowing HLA to attract top talent in a competitive market. HLA reported a 30% increase in the number of qualified candidates applying for open positions.
• Firm Valuation Growth: The improved employee engagement and increased retention contributed to a 12% increase in the firm's valuation within the first year. This was directly attributed to the long-term thinking fostered by the equity structure. The new strategic focus also increased the firms attractiveness as an acquisition target.

The strategic shift in compensation allowed Harrington Legacy Advisors to free up capital for expansion into new markets, directly contributing to the increase in firm valuation.

Key Takeaways

For other RIAs and wealth management firms seeking to optimize their compensation structures, the Harrington Legacy Advisors case study offers several key takeaways:

1. Prioritize Tax Efficiency: Explore opportunities to reduce the tax burden on both your firm and your employees through strategies such as deferred compensation plans, equity options, and qualified retirement plans.
2. Align Incentives with Long-Term Goals: Design your compensation structure to incentivize employees to contribute to the long-term growth and success of your firm, rather than solely focusing on short-term performance metrics.
3. Communicate Clearly and Provide Education: Ensure that your employees understand the details of your compensation plan and the benefits it offers. Provide them with the resources they need to make informed decisions about their compensation and financial planning.
4. Utilize Technology: Leverage specialized financial tools and software to model compensation scenarios, manage deferred compensation and equity options, and ensure compliance with applicable regulations.
5. Regularly Review and Adapt: Regularly review your compensation structure to ensure that it continues to meet the needs of your firm and your employees. Be prepared to adapt your plan as your firm grows and market conditions change.

About Golden Door Asset

Golden Door Asset builds AI-powered intelligence tools for RIAs. Our platform helps advisors identify tax optimization opportunities within client portfolios, automate compliance tasks, and gain insights into client behavior. Visit our tools to see how we can help your practice.