- Equity compensation gives you ownership in your company. Different offerings include stock options and restricted stock units.
- Mid- and late-career workers face the risk of heavy concentration in their own employer’s stock. They must also prepare for the tax consequences of exercising and selling shares.
- Only 7% of stock plan participants polled by E*Trade said they sell or exercise to get optimal tax treatment.
If your employer is giving you ownership shares as part of your pay, you could be accumulating wealth — or you could be ramping up risk.
Equity compensation is a way for companies to reward employees who meet certain performance goals and incentivize them to stay.
As attractive as this benefit sounds, employees often have a hard time grasping how it works.
Just three in 10 people in a recent survey by E*Trade said they understood how to potentially maximize the financial benefits.
The brokerage firm surveyed 60,277 of its corporate clients' stock plan participants in April.
"Understanding an inherently complicated benefit is difficult," said Scott Whatley, president of E*Trade Corporate Services. This work perk carries a lot of complexity, including a possible tax hit.
Failing to fully comprehend your award can come with steep costs, especially if you're a mid or late-career worker with a hefty wealth concentration in your employer's stock.
"What would you do if all your eggs are in one basket and the value drops 30%?" said Dan Herron, CPA and partner at Better Business Financial Services. "How likely are you to accomplish your retirement plan?"
Your stock compensation strategy will depend on what you hold.
Restricted stock units grant employees shares at a future date. You don't receive the actual stock holding on the day of grant. Rather, there must be a vesting period first.
With so-called RSUs, you pay taxes when your holdings vest and you receive the shares.
Stock options allow workers to buy a certain amount of stock at a specified price — known as the strike price — after a vesting period at some point in the future.
When you exercise the option, you are buying stock at the strike price.
As a result, the option has value when it's "in the money" — or when the price of the stock at exercise is greater than the strike price.
The tax load you'll owe on your stock options will depend on what you have.
Workers don't pay taxes on incentive stock options at receipt or exercise. Instead, they pay capital gains taxes after selling the stock they've purchased.
They may also qualify for preferential long-term capital gains treatment — a top rate of 20% — if they meet a set of rules from the IRS.
High income workers with so-called ISOs could be subject to the alternative minimum tax on the difference between the market price and share price at exercise. Talk with your CPA before you proceed.
Finally, employees with non-qualified stock options pay ordinary income taxes — a top rate of 37% — at exercise. If your shares appreciate and you sell them, you pay a capital gains tax, too.
To manage your holdings, work with your financial advisor or accountant to draft a plan to sell some of your company stock in increments.
"These professionals tend to allow their holdings to accumulate over time, and only pay attention when something is about to expire and it forces their hand," said Tara Thompson Popernik, director of research at AllianceBernstein's Wealth Strategies Group.
What you do with the proceeds is also important: Those approaching retirement could use the money strengthen their cash reserves, or they could reinvest the money and diversify their overall portfolio.
Be mindful of dropping one risky position for another.
Indeed, 6 out of 10 participants in the E*Trade study said that when they consider reinvesting their proceeds, they're thinking of plowing their money into individual stocks.
"By looking at each tranche of stock options individually, you'll have the opportunity to better manage and better diversify your portfolio and get more wealth in the end," said Popernik.
Don't set-and-forget your company stocks.
Review your holdings: "Get an initial read on where you are, especially if you've accumulated different grants and tranches of options and restricted stocks over the last few years," said Popernik.
This way, you get a sense of your concentration risk.
Find a strategy: Don't overlook your stock plan during your annual meetings with your advisor. It can be an essential component of your retirement.
Work together to devise a strategy on when to exercise, sell and diversify or build cash to meet your long-term goals.
Devise a tax plan: Stock plans come with tax consequences. Consult with your CPA and develop a strategy to mitigate your tax bill.
"If you exercise this amount, what are the income consequences and how far can we go in the income tax bracket?" asked Herron. "It must fit into your overall financial plan, too."