By Vincent Barbera, CFP®, MSFS
When you’re in management, it’s common for your compensation package to include a lot more than just your salary. On top of healthcare and other benefits that all employees get, you’ve reached the elite group that gets equity compensation, like stock options and restricted stock units.
Usually your company starts to include equity in your compensation package when they think you’ve reached a level of influence where what you do could actually impact the value of their stock. They want to tie your incentives to the stock price in order to motivate you to make decisions that will benefit shareholders.
You’ve made it to management. You’ve been granted stock options. You’ve stayed with the company long enough for them to vest. Now what do you do?
What You Can Do With Vested Stock Options
Once your options vest, there are really only three routes you can take. Option #1 is to basically do nothing and just hang on to them. This is the easiest thing, as it requires no effort on your part. However, 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.
Things To Consider When Making Your Decision
So, you have three different possible routes that you can take once your options vest. Which is best? 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 to 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 are for you. Your tax situation and the type of stock options they are will influence which of those two choices are 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 are sold in order 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, or 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.
How We Can Help
At Newbridge Wealth Management, we specialize in helping busy professionals like yourself both make financial decisions and execute them. You don’t have the time and energy to become an expert in the intricacies of employee stock options and their tax implications. Let us do that for you.
If you have stock options that you need help figuring out or other financial questions that you simply don’t have the time to answer on your own, we can help you. Click here to access our online calendar and easily schedule a free 15-minute introductory phone call, or you can email us at vincent@newbridgewealth.com or call 610.727.3960 to schedule a meeting today!
About Vincent
Vincent R. Barbera, CFP®, MSFS is a managing partner and co-founder of Newbridge Wealth Management, a private financial counseling firm located in Berwyn, Pennsylvania. Believing in a patient, disciplined approach to investment management that delivers value and peace of mind, he utilizes a process-driven approach to financial planning that provides comfort and clarity to his clients’ long-term goals. Along with a bachelor’s degree in psychology and business, he has a master’s degree in business and financial planning and Certified Financial Planner™ designation. Learn more by connecting with Vincent on LinkedIn, or send him questions at vincent@newbridgewealth.com.
