Beneficiary designations are a surprisingly hot topic these days, with many experts now suggesting that they are not a good idea for stock compensation arrangements. We’ve looked at this issue before in the NASPP Blog (“Did Steve Jobs Have a Beneficiary?,” October 13, 2011), but we recently published the results of a quick survey on practices in this area, so I thought it would be a good time to take a look at the topic again.
The Allure of Beneficiary Designations
When they work, beneficiary designations work very well. The company has clear instructions on what to do with the deceased employee’s awards and can pay those awards out relatively quickly, with minimal documentation from the beneficiary (perhaps just a death certificate, instructions on how to distribute the awards, and documentation to complete any required tax reporting).
Without a beneficiary designation, the awards transfer to the heirs in accordance with the rest of the deceased employee’s estate. Unless some sort of trust arrangement that includes the employee’s awards has been set up, this likely means that the awards will have to go through probate. Depending on the size of the estate, probate can be expensive, can require the assistance of an attorney to navigate, and can take a long time (note however, that many states have expedited and simplified probate processes for estates that are less than a specified amount).
When Beneficiary Designations Go Bad
The operative phrase in the section above is “when they work.” When beneficiary designations don’t work, things get ugly. Beneficiary designations need to be regularly updated for life changes (marriages, divorces, births, deaths, etc.). And they need to comply with applicable local laws–in the US, state laws can inhibit the effectiveness of beneficiary designations; outside the US, this is even more of a problem. Where the validity of a beneficiary designation is called into question, the matter will likely end up in court–which can be a lot more expensive and slower than probate. Of greater concern, where a company pays out an award pursuant to an invalid beneficiary designation, in some countries the company could be liable to the rightful heirs.
If you are going to allow plan participants to designate beneficiaries for their awards, you’ll need a process for collecting and tracking the designations. You also really should have a process to remind participants to update their designations periodically–otherwise someone’s stock awards could end up being paid out to an ex-spouse (as described in the blog entry noted above). And, particularly for non-US participants, you should have a process for verifying that the designations don’t conflict with local laws.
All of which seems like a lot of work for something that few participants will benefit from. In the NASPP’s recent quick survey on the topic, 87% of respondents reported that fewer than five participants die while holding outstanding awards per year.
Survey Says
How many companies allow beneficiary designations anyway? Well under half and sometimes as few as only one-third, depending on the type of award. Among respondents to our quick survey:
40% allow beneficiary designations for stock options
37% allow them for restricted stock/RSUs
32% allow them for performance awards
35% allow them for ESPPs
Note that for all four types of awards, there was a small percentage (less than 5%) of respondents that are considering or in the process of implementing beneficiary designations. The rest of the respondents do not allow them.
Of those that allow beneficiary designations and have non-US employees, 68% allow the designations for all of their non-US employees as well.
23% of respondents ask employees to update their beneficiary designations when they receive a new award and 12% ask for updates annually. 61% don’t ever ask employees to update their beneficiaries, which seems like a good way to get into a situation where you are paying out an award to an ex-spouse.
43% of respondents store paper copies of beneficiary designations in house, 19% have some sort of in-house automated or electronic tracking system, and 32% rely on a third party to track the designations.
Ding, ding, ding. That’s the sound of my inbox waking up to a flurry of alerts and articles about a recent Supreme Court decision that, turns out, affects stock compensation – sort of. On June 26, 2013, the high court ruled in the case of United States v. Windsor that Section 3 of the Defense of Marriage Act (DOFA) is unconstitutional. Section 3 of the DOFA was an attempt at uniformly defining marriage at the federal level, and that definition excluded same-sex marriages. The recent court ruling means that the definition of marriage is now back in the hands of the states, and there are currently 13 states and the District of Columbia that have enacted laws recognizing same-sex marriages. In jurisdictions where same-sex marriages are lawful, those in same-sex marriages are now considered to by married for purposes of any federal regulations or statutes that refer to one’s marital status.
How Does the Ruling Affect Stock Compensation?
The defeat of Section 3 of the DOFA means that we now must look at the various state statutes to determine the definition of “marriage” or “spouse” for purposes of employee benefits. Essentially, benefits subject to federal laws (ERISA, COBRA, Internal Revenue Code, etc.) fall under these provisions. According to a myStockOptions.com blog post on the subject, “While stock plans and nonqualified benefit plans are not affected by federal laws in the same way as qualified retirement plans (e.g. a 401(k) plan) or health and welfare plans, the changes that will be required in these other benefit plans will probably lead to similar modifications in stock plan documents.” Although there was nothing in the Supreme Court ruling that directly addressed stock compensation, it seems that when it comes to things like policies on divorce for purposes of stock options, or transferable options, death, and other situations where a “spouse” may be involved, it’s likely many companies would opt to align with practices in place for other benefit plans that are covered under the ruling. Therefore, even though stock compensation is not specifically covered under the ruling, it is indirectly affected. The possible areas that may need a review off the top of my head are:
Beneficiary designations
Plan Documents and Grant Agreements
Policies or communications on divorce and transferable options
The holding takes effect on July 21, 2013, so employers are working to immediately assess those plans affected. In addition, stock plan provisions and policies should be reviewed to align with changes being made to other covered plans (e.g. 401(k)). For example, if your stock plan mandates a default beneficiary of a “spouse” for stock options upon death, the term “spouse” may need to be redefined to include same-sex spouses where lawful. In addition, it’s likely that Human Resources and Legal are already working away to navigate this situation, so you may want to plug in now – things like employee communications and matters of policy going forward could be streamlined and should be addressed.
I’m still confused about some aspects of this – like is whether we need to look at the state where the marriage took place, or the state where the employee currently resides for purposes of applying state laws to the definition of marriage for employee benefit purposes. I guess that’s for the lawyers to figure out. Based on the number of alerts I got on this subject, they are already on that task. In a client alert, Paul Hastings gives a good description of the issues around determining applicable state laws and this entire situation in general.
The action item here is to talk to counsel and start reviewing your equity plan documents, policies and communications to determine where changes should be made. It seems logical that, just as we’ve migrated towards aligning with other benefit practices (401(k), etc.) in the past, it would make sense to similarly consider adjustments to stock plan matters in tandem with changes to required benefit plans. Just when it seemed summer was starting to fall into a rhythm of lazy, hot days (is there such a thing as a lazy day?), there’s never a dull moment.
In our world of stock compensation, we’re well versed in keeping up with the laws and regulations that govern our universe. Many of us are also in tune with doing what it takes to keep our employee customers informed and happy. Sometimes in the quest to tighten up policies or service the employee, seemingly good practices are utilized, only to learn later on that they weren’t such a hot idea after all. In today’s blog, I’ll explore a few common, well-intentioned practices that may come back to later haunt the stock plan administrator.
3 Practices With Potential Pitfalls
1. Thinking Beneficiary Designations are a Must: Contrary to some stock plan urban myth that says it’s a good idea to allow employees to designate a beneficiary for their stock plan shares, the use of beneficiary forms for stock plan shares is not considered a best practice. Why? Well, this is an area where I could rant a long laundry list of “whys”, but in the interest of space I’ll keep it short. One reason? There’s a good chance that the designated beneficiary may not be the intended beneficiary. These forms are usually completed when someone is new to a stock plan, and then later forgotten. Years go by – marriages, divorces, other life events. It’s quite possible that the name written on the beneficiary form is not the person who would have been the intended recipient. Another reason to ditch these forms: many non-U.S. jurisdictions don’t even consider beneficiary forms to be valid or enforceable. According to a recent white paper published by Baker & McKenzie on this subject (and available in our NASPP Practice Alerts), it’s better just to simply provide for a refund of unused ESPP contributions in the event of death, and other stock plan rights, such as those to stock options, go to the employee’s estate. Another option may be to allow the use of beneficiary designations at the stock plan administrator’s discretion (to allow for one-off situations that may warrant such a designation), but not as the rule.
2. Believing that Unsigned Grant Agreements Can’t be Enforced: Many companies do distribute grant agreements to grant/award recipients, and the vast majority require a signature (including electronic signature or acceptance) on the document. According to the 2011 NASPP/Deloitte Stock Plan Administration survey, 76% of participating companies reported requiring grant acceptance (although 24% of respondents said that they don’t enforce the requirement). In a recent California Court of Appeals case, an unsigned stock option agreement was deemed to be valid. The facts surrounding the case are lengthy and detailed, so that will have to be reserved for a future blog. However, one lesson learned from the decision was that, absent language that indicates acceptance or signature is required or presumed at a certain point, it is possible for an unsigned agreement to be considered an agreement. I’m guessing a good number of companies operate on this belief, at least those that aren’t requiring acceptance or enforcing their acceptance policies. However, there may be a segment of companies that believe that there’s a black and white difference between signed and unsigned agreements, leading to a false sense of security about only having a true agreement if and when it’s actually signed. The recent court case seems to blur that line. If you are concerned about making sure the company and employee are on the same page about what’s being offered and the terms and conditions of the award, it’s a good idea to require acceptance or signatures. In addition, having a policy or requirement is just the first step. Perhaps even more important is consistency in enforcing the policy. No one wants to to lose a valid dispute based on a technicality. At minimum, be aware of the potential for enforcement of unsigned agreements.
3. Mobility Tax Calculation Assumptions: Not all countries have the same mentality when it comes to calculating their share of the tax pie for mobile employees. The tax authorities of many countries are still trying to figure out how to tax mobile employees, and this an ever-evolving area. Some companies find themselves trying to take a one-size-fits all approach to streamline mobility related tax allocations. This simply won’t work – there are too many differences amongst jurisdictions, and if that wasn’t enough, the interpretations and policies keep changing. For example, the Canadian Revenue Agency recently changed its position on the calculation of cross-border stock option benefits, clarifying some aspects of its policy on how stock option income should be allocated. This was a positive change, providing some clear guidance in an area that previously had ambiguity. These types of clarifications or updates are becoming commonplace, and companies do need to accept that the approach to mobile employees still needs to be determined on a jurisdictional or case-by-case basis.
Sometimes it’s not the big changes that matter, but the little shifts in our practices or thinking. It’s quite possible to make a big difference with a simple change in policy or practice. Hopefully in today’s blog you gained a couple of nuggets that may prompt some small shift in approach, netting rewards down the road (and avoiding the haunting I referred to at the beginning of this blog).
I was saddened to learn of the death of Apple Inc. co-founder and chairman, Steve Jobs, last week. Whether or not you are a user of Apple products, surely you can appreciate the contribution Mr. Jobs made to global technology.
The Legacy We Leave Behind
While Mr. Jobs’ passing was on my mind, I wondered about his restricted stock holdings and how his massive empire would be transitioned to his intended heirs. I realized that this was a good reminder about estate planning. No one likes to talk about death, but since immortality is not a clause that exists in stock plan (or any other) agreements, planning for the inevitable is a wise step. I’d prefer to have my descendants reflect on the positive impact I had on their lives, rather than the way I bungled their inheritance!
Does Designating a Beneficiary Help?
There are varied opinions about whether beneficiaries should be designated for stock plan grants and awards, such as stock options or restricted stock. Maintenance of such designations and the fact that generic beneficiary forms can be problematic due to varied local estate regulations are some of the core arguments against the use of such forms. See Robyn’s 2009 blog on this topic. The issues with designating beneficiaries have taken center stage in recent court cases. In January of 2009, the U.S. Supreme Court ruled, in the case of Kennedy, executrix of the Estate of Kennedy v. Plan Administrator for DuPont Savings and Investment Plan et al, that a deceased man’s pension plan was to be paid to his ex-wife, based on a 27 year old beneficiary designation that the man filled out shortly after his marriage. Even though their divorce decree years later had divested her rights to his pension plan, he never changed the beneficiary with the plan administrator. This failure to change the beneficiary designation resulted in what appears to be an unintended payment to his ex-spouse rather than to his estate. I think many would agree it’s reasonable to assume that was probably not the outcome he’d had in mind in crafting his estate plan.
Reflections
I’m guessing that Steve Jobs had a solid estate plan in place. He certainly had the benefit of having enough resources to engage top advisers to assist him in this area. In general, the loss of another often prompts us to evaluate our own mortality. As individuals, it’s a timely reminder to have our ducks in a row, and to periodically assess the plan to ensure our instructions reflect our most current intentions. Has there been a change in the family (marriage, divorce, death or birth) that would impact prior designations? As plan administrators, it’s also an opportunity to nudge our employee populations about doing the same, with a reminder about how the company will handle such a situation administratively and what documentation may be required. An unpleasant topic? Yes. Yet we should be talking about it, because it’s an area where informed planning can make a world of difference. Year-end is just around the corner. In preparing the related employee communications, consider including a reference to estate planning. We send out about reminders about much more routine things such as to set our clocks back an hour, or that the social security tax withholding accumulator resets on January 1st. Why not include some important information on how they can manage their estate planning in line with company policy? You may also want to visit the session at the 19th Annual NASPP Conference on Death, Taxes and Senior Executives: Estate Planning and Retirement Programs.
Wow – it’s a light-hearted week here at the NASPP! As a follow-up to my post on tax withholding and reporting, today I’d like to address some steps stock plan administrators can take to prepare for the unfortunate event of an employee death.
Availability of Shares
The first step in preparing for efficient handling of an employee death is to know you plans and grant agreements. You need to know how the death will impact different equity vehicles.
Typically, the post-termination period for exercises is at least 12 months for death. This is because of the time and effort it takes to provide the correct documentation. In addition to knowing the period of time an employee’s estate or beneficiary has to exercise vested options, check to see if your plan or grant policy addresses the situation of a participant who dies within the standard post-termination exercise period.
For restricted stock, confirm whether or not unvested shares will accelerate or continue vesting. If there are any required post-vesting holding requirements associated with your restricted stock grants, check to see if these requirements apply to the estate or beneficiary.
If you have an ESPP, confirm that either your plan document or official policy addresses the issue of how contributions will be handled in the event of a death part-way through an offering period. Most companies do not allow the contributions to stay in the plan, but some do, and it is permitted under Section 423. For purchased shares that transfer to the estate or beneficiary, the statutory holding periods no longer apply.
Required Documentation
Unfortunately, it’s difficult to have a blanket policy on documentation required across all jurisdictions. Some companies use beneficiary designation forms to pass equity compensation on to an employee’s beneficiary. I would submit a word of caution against generic beneficiary forms for equity compensation–see Robyn’s blog entry on this topic for more information. Here are a few types of documentation that your company may determine is necessary in order to permit the estate or beneficiary to exercise:
Death Certificate: This is a pretty standard requirement, which will be needed for all types of inheritance issues.
Will: Also known as the “Last Will and Testament”, a will establishes how all of the assets of the decedent will be distributed and should include equity compensation. Generally, an executor will be named in a will and will be tasked with the process of overseeing the distribution of assets in the will. It is generally too risky for the company to attempt to prove that a will is, in fact, the most recent version and how to interpret its contents.
Court Documentation: All jurisdictions have some official body that establishes the official distribution of assets. These official documents will most likely be required by the broker, life insurance company, and other entities that hold assets which need to be distributed. It would be a massive investment in time and resources to identify which official documentation is applicable to each jurisdiction and asset level, so I don’t recommend attempting to identify this in advance. However, it is a good idea to identify your resources in each country for assistance in this matter, should it come up.
Held Shares
Brokerage firms have their own policies and procedures about transferring held shares to the estate or beneficiary. Although this process is essentially completely separate from your company’s process, it can be confusing and stressful for your employee’s heirs to understand that. Similar to educating employees about taxes on equity compensation, there is a fine line between making the process easier and providing legal advice. It’s good to consider how to handle this situation in advance, particularly for international beneficiaries. An important preparation you can make is to meet with your preferred brokers and identify the steps beneficiaries must take and who at the brokerage to contact in the event of an employee death.
Less than One Week Left!
You have through next Tuesday to take advantage of the NASPP’s New Member Referral Program. You can earn $150 off your NASPP Conference registration and an entry into a raffle for an iPad for each new member you refer to the NASPP–and the new members you refer can save 50% on their NASPP membership for 2010. Don’t let this deadline slip by!