Making the Most of Your Employee Stock Plans

Making the Most of Your Employee Stock Plans

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If your employment compensation includes employee stock plans, this is quite the stroke of luck. These benefits can be a great way to supplement your paycheck — or even build life-changing wealth. But a favorable outcome is by no means a given.

The rewards you reap can vary greatly depending on how well you manage your plans. It’s not an exact science, and not all variables are within your control, but a thoughtful, faithfully executed strategy can boost your odds of succeeding.

Understand the Details

These programs come in several flavors, each with its own attributes, constraints, and tax implications. Details vary from company-to-company, and even employee-to-employee.

Step one, then, is to determine which plan or plans you have, and understand the unique features of each. In general, they fall into three categories:

The first type, stock options granted to you, come in the form of Non-Qualified Stock Options (NSOs) or Incentive Stock Options (ISOs.) These plans permit employees to purchase a specified number of shares at pre-set prices on predetermined dates. Options often vest, i.e., become eligible for exercise and sale, in multiple lots spread out over several years.

Secondly, you may receive restricted stock, or the company’s promise to grant you future shares, a.k.a. Restricted Stock Units (RSUs.) These shares are subject to constraints on when they may be sold, typically based on company performance or a vesting schedule.

Finally, Employee Stock Purchase Plans (ESPPs) entitle you to buy company stock at a discounted price. This is usually done via payroll deductions over a predefined period, often six months. When time is up, the money set aside is used to purchase stock for up to 15% off the lower of its starting or ending fair market value.

Things to Consider

Once you have a handle on the nature of your plan(s), the next step is to zero in on the factors needed to make informed decisions. Here is what you need to consider:

Timing is everything. In addition to vesting schedules and ESPP terms, lock-up periods and blackout dates may impose restrictions on when you can sell shares. Also, awards may expire on a certain date or at termination.

Taxes play an outsized role. The value of shares granted to you is taxable at the federal and state level, as is subsequent capital appreciation. The applicable tax rate depends on your personal tax situation, the timing of exercise and/or sale of shares, plan type, and more.

ISOs, for example, enjoy especially favorable — but tricky — tax treatment. Assuming you meet holding period requirements, a greater portion of ISO-related income qualifies for long term capital gains rates (max 20% vs. up to 37% for ordinary income.) Furthermore, ISOs are not subject to payroll taxes or withholding. The downside? Alternative Minimum Tax (AMT) may be due.

Stock performance, of course, is another big factor. This may be harder to predict than other pieces of the puzzle, but factors such as employer outlook, stage (pre/post-IPO), track record, and sector volatility can provide insight. And, don’t forget market risk – even if your company is an outstanding investment, it can still be impacted by a bear market.

A Pragmatic Approach

By now you have probably realized that, as an employee stock plan participant, you’re dealing with a lot of moving parts. A “seat of the pants” approach is likely to result in missing deadlines and peak stock valuations, i.e., money left on the table. Plus, with so much at stake, emotions can run high, tempting the unprepared to make costly missteps.

So how do you craft a strategy to set yourself up for success?

Luck is what happens when preparation meets opportunity

What’s needed is a long-range plan grounded in reasonable assumptions and careful analysis. If you have multiple lots of several plan types vesting at different times, your plan should include deciding which lots to target for sale and when. Ideally, you would devise a sell strategy that leverages long-term capital gains tax rates when possible, avoids AMT, and spreads income across multiple years to avoid jumping tax brackets. You would also incorporate tax-loss harvesting and other tax planning strategies to offset these gains.

Still, it is important not to let the tax tail wag the investment dog. No sense holding out for a more favorable tax rate if it means running the risk of overconcentration. If you do not have a divestment plan, your shares may grow to represent a disproportionate share of your portfolio. As with all investments, a concentrated position means higher risk. That risk is magnified by the fact that your salary comes from the same source.

To avoid the risks of a concentrated position, target a maximum allocation of company stock. Depending on your risk tolerance and unique financial situation, consider a maximum of 10% your portfolio. Beyond that, aim to diversify out of some company shares. Hint: if you’re bullish on the stock, this could be the toughest part.

We cannot direct the wind, but we can adjust the sails
With employee stock plans, only one thing is guaranteed: change. You could receive new shares. Your old shares vest. Your spouse’s new job could land you in a higher tax bracket. The stock could soar or nosedive. There is no way of predicting what lies ahead. While it is crucial to review and execute on your plan regularly, it is equally important to stay flexible and be open to pivoting if circumstances dictate.

All this planning takes a lot of work and tracking, especially when there are trading windows involved. If you don’t have the time or inclination to do it yourself, let us help. We will work with you to develop a plan, assist you with implementing recommendations, and monitor your progress to keep you on track.

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