On average, equity compensation makes up 32% of employees’ total net worth, making it one of the best opportunities to build long-term wealth.
However, the value of your equity compensation is tied to more than just the performance of your company’s stock.
Unlocking the full value of your equity requires a sound understanding of your plan’s rules and restrictions, as well as thoughtful financial planning around taxes, concentration risk, and your personal goals.
Types of Equity Compensation
Different types of stock-based compensation have different rules in terms of vesting, exercise periods, and taxation. It’s important for you to know what these are to ensure that you make the most of this type of compensation.
- Non-qualified stock options (NQSOs)
- Incentive stock options (ISOs)
- Employee Stock Purchase Plans (ESPPs)
- Restricted stock units (RSUs)
- Stock appreciation rights (SARs)
Equity Compensation Rules & Restrictions
Beyond knowing that you have received a stock grant or stock option, you need to understand how this stock compensation award works.
- What is the vesting schedule?
- Are there any expiration dates to be aware of?
- What are the payout rules?
- What happens if you leave the company?
Different types of equity compensation have their own unique rules around converting shares into stock, when you can sell the shares, and your rights should you leave your employer.
Working with your advisor to fully understand these rules is best way to avoid missed opportunities and/or violations of your plan’s rules and restrictions.
Tax Implications of Selling Stock
Different types of stock compensation plans also have different tax implications when you sell the related shares.
In some cases, the sale of shares can trigger ordinary income and even subject you to the alternative minimum tax (AMT). Some (ISO, or incentive stock options) require a certain holding period to receive preferable capital gains treatment.
An 83(b) election can be used for restricted stock to shift ordinary income to capital gains treatment, but there are implications and IRS rules around this technique.
While taxes generally shouldn’t drive your investing decisions, you should nonetheless be aware of the tax implications of any sale of company stock or the exercise of any options, RSUs, or stock appreciation rights so you can plan to offset the impact of these taxes during the year if possible.
In the case of company stock held in your 401(k), you need to understand the net unrealized appreciation (NUA) method of dealing with these shares should you leave the company. Under the NUA rules, you can rollover any 401(k) assets other than the company shares into an IRA or another employer’s 401(k) plan to retain the tax-advantaged status of this money.
Under the NUA rules you can take a taxable distribution of your company stock at your cost basis in the shares. If you then hold them for at least a year, you can sell the shares and pay taxes at the preferential long-term capital gains rate. This can generate significant tax savings in many cases.
Should I Sell My Company Stock?
Your strategy around selling your company shares should be intertwined with your overall financial goals and priorities. At the end of the day, the shares are part of your compensation and should be viewed as investable assets to be deployed in the best fashion that aligns with your overall financial priorities and investing strategy.
Priorities may include:
- Wealth transfer to the next generation of your family. Using appreciated shares as part of an annual gifting program may make sense.
- Reducing the concentration risk you have as a result of your employer-sponsored equity compensation.
- Appreciated shares can be a great tool for funding charitable giving goals.
- Directing a portion of your investment assets into private investment opportunities or to the purchase of assets such as real estate or others.
Diversification and Concentration Risk
One of your key considerations in determining when to sell company shares is your overall portfolio diversification. While your company’s equity represents a great wealth creation opportunity, it’s important that its value doesn’t represent a disproportionate percentage of your total net worth.
A concentrated equity position alongside cash compensation from the company can put you in an overly risky position if things were to go badly with your employer.
If you find yourself with a portfolio that is becoming concentrated in your employer’s stock it is time to look at selling some of the shares and reinvesting that money elsewhere. This can help to maintain a proper asset allocation in your portfolio and help mitigate the risks inherent in a concentrated employer stock position.
Regardless of whether your company stock results in a concentrated position, these shares should be treated like any other component of your portfolio in terms of being invested in the most advantageous way, and in terms of supporting your target asset allocation.
Stock compensation can take various forms and is generally a positive for employees who receive it. Once you receive your stock compensation, it is important to decide how and when to invest this money in the best way for your situation.
Understanding the rules surrounding the type of stock compensation you’ve received is critical. It is also critical to make a good decision as to if and when to sell your shares in order to maintain your overall asset allocation and to deploy this money in the best way for your situation and priorities.
Working with an advisor with expertise in advising clients on all forms of stock-based compensation can help in making the best decisions for your situation.