If you work for a company whose share price is trending up, and whose management favors incenting and rewarding employees with stock options, you might be in an enviable position. Although the use of options as a factor in compensation packages has become more widespread, many employees are still confused about their rights and responsibilities, as well as how these options impact your financial and life planning.
We at KHC Wealth Management have been helping our clients with complicated compensation packages, including stock options, for 20 years. There are many issues to address in this situation, we’ve compiled a list of four helpful considerations as you incorporate options into your financial planning.
Set some goals for use of the options. Will they be used for meeting current economic needs, such as a new addition to your home, or are they part of your long-term financial plan, which may include funding an early retirement or a child’s education?
Create a strategy for utilizing the options. For example, you may want to stagger the exercises and subsequent sales over a period of years to help lessen the impact of taxes. Deciding randomly, at the beginning or end of each year, to exercise or sell during the year may generate unnecessary taxes or reduce opportunities for additional gains. A traditional stock option is good for up to ten years in the future. If the prospects for your company are strong, you may be better off waiting to exercise options. You should, however, keep track of expiration dates.
Read the option plan and your grant agreement carefully. These documents inform you of your rights if you are fired, resign, go to work for a competitor, retire, become disabled, or die. Many plans allow an employee 90 to 180 days to exercise vested options after retirement and disability. Usually, options are lost if an employee works for a direct competitor. You should discuss the details of your plan with spouse or partner, financial professional, and legal professional they can be prepared to act on them if needed.
ISOs or NQSOs? The option documents should also tell you if you have incentive stock options (ISOs) or nonqualified stock options (NQSOs). Each has a different impact on your taxes. With NQSOs, you will owe taxes at your ordinary income rate on the spread between the option exercise price and the market price, whether or not you immediately sell the share. However, with ISOs, if you hold the shares for a year or more, you will be subject to the alternative minimum tax (AMT). The AMT rules require you to include the spread on exercise of ISOs in a calculation of alternative income that is used to recalculate your tax.
If you have accumulated a significant number of options, and they represent more than 25 percent of your net worth, diversification may be more important than waiting to exercise your options. Some companies consider stock ownership an implicit requirement for advancement. In this case, you must exercise some of your options and purchase shares. As always, it is a good idea to consult an accountant or legal professional for specific advice concerning your options. Make sure this professional is someone who works with stock options and is familiar with the laws relating to them.