By Dave Coen
When people hear phrases like employee stock options and vesting schedules, they may scratch their heads in confusion and move on. If you’re one of the lucky ones who receive stock options as part of your employee benefits plan, don’t be like the 48% of people who have avoided taking action for fear of making a mistake. (1)
The decisions (or lack of decisions) you make with your vested stock options could lead to disaster down the road if you don’t understand the ins and outs of how they work. If you’ve been granted stock options and stayed with your company long enough for them to vest, read on.
An Employee Stock Option Primer
Here’s an overview to help you wrap your head around stock options. Employee stock options offer the employee the right to buy a certain amount of company shares at a predetermined price for a specific period of time. Your options will have a vesting date, which means that after a certain amount of years, you can exercise your stock options.
Let’s say you work for company XYZ and they have issued employee stock options to you at $50. In this scenario, you would have the right to purchase 1,000 shares of XYZ stock at $50 (the grant price) after three years (the vesting period) and within ten years (the expiration date) of the grant date. Until your options vest, there’s nothing for you to do. But once you reach that magical date, it’s time to act.
Your Three Choices
Once your options vest, there are really only three routes you can take:
- Option #1 is to do nothing and just hang on to them. This is the easiest path, as it requires no effort on your part. On the downside, you also receive no immediate financial reward.
- Option #2 is for you to exercise the options and hold the stock. This is where you go ahead and make use of your options to buy stock at the discounted exercise price. Once you’ve purchased the stock, you keep it as a part of your portfolio. This will increase your portfolio value, but you will receive no immediate cash reward.
- Option #3 is to exercise the options and then immediately sell the stock. This allows you to quickly convert your options to cash for use in other areas of your life.
What Should I Do With My Stock Options?
So, of these three possible routes to take once your options vest, which is best? Well, the best choice for you will depend on a variety of factors. Here are some things to take into consideration when making your decision.
Asset Allocation
Do you want to own company stock? If the answer is no, then Option #2 is not the one for you. If you think your company’s stock will increase in value, then you may want to go with Option #1 and wait to see how much of a gain you can realize. There is a risk in waiting, though, as the stock price could decrease. If you just want to take the money and run, you’ll probably opt for Option #3.
If you do want to own company stock, then Option #1 or Option #2 may be your best bet. Your tax situation and the type of stock options they are will influence which of these two choices is best.
When contemplating whether or not you want to own company stock, you should consider diversification. Owning company stock does not only impact the diversification of your portfolio, but also your net worth and income-earning potential. If your company fails, it’s not just the stock that you may lose out on, but you could also lose your job and source of income.
Cash Or Cashless Exercise?
With stock options, you’re not actually given the stock. Rather, you’re given the right to purchase stock at a specified price (hopefully lower than market value at the time of vesting). Since it is a purchase, you need funds to make the purchase. If you have enough cash, you can pay for the stock and/or tax withholding with it in what is called a cash exercise.
Even if you don’t have cash, you can still exercise your options in what is called a cashless exercise. In a cashless exercise, a portion of the stock shares is sold to cover the cost of the purchase and/or taxes. You don’t need any cash up front, but you end up with fewer shares in the end.
Whether you do a cash or cashless exercise will first depend on whether or not you have the cash available to you. If you don’t, you have no choice but to go with a cashless exercise. Even if you do have the cash, you may choose to reserve it for other purposes and still do a cashless exercise.
Taxes
Stock options are compensation and are therefore taxed. The kind of options they are, whether Incentive Stock Options (ISOs) or Non-Qualified Stock Options (NSOs), will determine how they are taxed. There’s a good chance that your stock options are also subject to the Alternative Minimum Tax (AMT).
Since the tax impacts of stock options can be significant, it is important to work with a financial professional with experience in this area when deciding when and how to exercise your stock options.
Still Scratching Your Head?
I understand and I’m here to help. If you have stock options that you need help figuring out or other financial questions you simply don’t have time to answer on your own, I can help you. Get started by emailing me at dcoen@sageviewadvisory.com or calling 800-814-8742.
About Dave
Dave Coen is a Financial Advisor with SageView Advisory and the CEO of College Planning America. Along with his retirement financial industry experience, he is a College Planning Specialist. He works closely with individuals and families to provide comprehensive financial planning that addresses all elements of their financial picture. Learn more by connecting with Dave on LinkedIn.
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Registered Representative with Cetera Advisor Networks LLC, Member FINRA/SIPC. Advisory services offered through SageView advisory group, LLC. Cetera is under separate ownership from any other named entity. CA insurance license #0G82578
This material is designed to provide accurate and authoritative information on the subjects covered. It is not however intended to provide specific legal, tax, or other professional advice. For specific personal assistance, the services of an appropriate professional should be sought. A diversified portfolio does not assure a profit or protect against loss in a declining market.
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(1) https://www.cnbc.com/2018/02/27/employee-stock-options-can-come-with-expensive-risks.html
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