By: Colleen Weber
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By Colleen Weber, CFP®, CPA
While many people have access to employee stock options through their employer, the process and details are often confusing. Between taxation, diversification, and more fine print than you know what to do with, it would be easy to stick your head in the sand and not take advantage of your stock options. But stock options can benefit your overall financial plan if you have the right information and make wise decisions. That’s what I want to help you with. So, if you’ve been granted stock options and stayed with your company long enough for them to vest, keep reading.
The Ins And Outs Of Employee Stock Options
Let’s get back to the basics. 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 10 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.
What Can I Do With Vested Stock Options?
Once your options vest, there are really only three routes you can take. Option #1 is to do nothing and just hang onto 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.
Points To Ponder
So, you have three different possible routes that you can take once your options vest. Which is best? The right choice for you will depend on a variety of factors. Here are some things to take into consideration when making your decision.
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 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 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.
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 experienced in this area when deciding when and how to exercise your stock options.
Ready To Maximize Your Stock Options Benefit?
I 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 me 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, I can help you. Book a free introductory meeting online today!
Colleen Weber is a fee-only financial advisor, CERTIFIED FINANCIAL PLANNER™ professional, and CPA with more than 15 years of financial planning experience. Providing comprehensive financial planning and wealth management, she specializes in serving clients nearing retirement, retirees, busy professionals, and women. She is passionate about developing financial plans that save clients on taxes, and investment strategies that help them pursue their goals. Learn more about Colleen by connecting with her on LinkedIn or booking a complimentary phone call meeting.