How to Maximize the Benefits of Incentive Stock Options

March 02, 2017

If your employer is providing you incentive stock options (or ISOs) as part of your compensation, they’re giving you a stake in the success of the company (or at least the stock price). ISOs can be complicated though. To make sure you’re taking full advantage of the opportunity they offer, here are some questions to ask yourself:

Are you subject to AMT (the alternative minimum tax)? When you are granted the options and when they vest, there’s generally no tax (assuming they’re priced at the current fair market value of your employer’s stock). When you exercise the option, there’s also generally no tax (unlike with nonqualified stock options, which are subject to income and employment taxes when exercised).

However, there’s an exception that your gain when the option is exercised is considered income for purposes of calculating the AMT. For this reason, you may want to wait to exercise the option until a year when you’re not subject to the AMT. If you’re not sure when that might be, consult a tax professional for guidance.

How long has it been since you’ve been granted the option and exercised it? In order to qualify to pay a lower capital gains rate on all the gain, you need to wait at least 2 years from when the option was granted and one year since you exercised the option before selling the stock. If you sell the stock before then, you’ll have to pay ordinary income tax on the difference between the value of the stock when you bought it and the fair market value of the stock at that time.

It pays to wait, but not too long. Options (or the employer stock after you exercise the option) are risky because your money is tied up in just one stock. That’s why you may want to exercise your options and sell the stock to diversify the money as soon as you’re eligible to do so at the lower capital gains rate.

How much of your net worth do the options represent? If it’s more than 10-15% and you need to hold on to them for tax purposes, you may want to talk to a financial advisor about what options (no pun intended) you have to hedge against the risk of a falling stock price. Otherwise, you may see a significant decline in your net worth should something happen to the stock price.

Incentive stock options can be a great opportunity to participate in the success of your company. However, there are many pitfalls to avoid. Just make sure you understand all the ramifications before making any decisions and consult with qualified financial or tax professionals as needed.

 

 

Is Too Much of a Good Thing a Bad Thing?

December 02, 2016

During some recent conversations with employees of a publicly traded company, the topic of company stock was very popular.  This company’s stock price has tripled (300% gain, point to point) in the last 5 years, while the Dow Jones Industrial Average has increased over 50% (from ~12,000 to ~19,000).  What that has done to employee 401(k)s, for those who contribute to company stock inside the plan, is ratchet up the percentage of company stock beyond the 20% limitation that the firm’s policies allow. For those who have participated in the employee stock purchase plan (ESPP) or who receive some form of equity compensation (restricted stock, stock options), their company stock holdings could even be higher.  The question around their building during these conversations was “do I have too much company stock?”

My answer to that question was almost always “it depends!” Most financial planners will recommend that no more than 10-15% of one’s portfolio should be in employer stock.  Employees at Apple or Google would disagree with that, while employees of MCI WorldCom and Enron think that is probably 10-15% too much. While that rule of thumb is out there, it is often misconstrued.

I spoke with one employee recently who had 40% of her 401(k) in employer stock and she was concerned because her financial advisor told her that was far too much to have. When we broadened the scope, from just her 401(k) to her total portfolio, we found that only 5% of her total wealth was in employer stock. She had most of her money in CDs at her local bank and in a portfolio of bonds with her financial advisor. Her employer stock was almost her only growth asset. We did talk about more broadly diversifying her portfolio and about allowing her financial advisor to know that she had the CDs at the bank too so that his recommendations could be with the full knowledge of her situation.

The lesson: When looking at employer stock, look at the whole picture not just one account.

I spoke with another employee who had 15.1% of employer stock in his 401(k) and his plan provider had a big red warning sign on his 401(k) one day. If the stock price fell and the stock became 14.9% of his plan, the red warning sign would go away the next day. He was right on the edge, as he viewed it – and as his 401(k) plan provider viewed it.

He wasn’t too concerned because he is highly optimistic about the company’s future. During our conversation, he convinced me that he totally understood the risks associated with having one stock be too big a portion of a portfolio. When I asked a follow up question about equity compensation and the ESPP, he told me that an amount equal to his 401(k) balance was sitting in company stock through the ESPP and restricted stock grants.

So 65% of his investable asset base was in company stock, and this company is going through a merger that may be wonderful or dreadful for the company stock price. Upon realizing that, I asked “Are you more concerned about your stock price doubling right after you scale back your holdings or the stock price falling by half if you don’t scale back your level of holdings?” He was far more concerned about the stock price falling if the merger didn’t get approved or if the overall stock market tanks after 8 years of increases so he opted to scale back some of his holdings by selling ESPP stock and paying off his mortgage.

The lesson: Be aware of where the overall markets are, what your risks are and the full scope of your holdings.

To answer the question of “How much employer stock is too much” requires a fairly thorough understanding of your financial life and goals, the economy, current events/news regarding the company and your willingness to accept large losses in an attempt to make large gains. I’m certain there are people at Google who wish they could buy nothing but Google stock, and I know for sure that there are people who once worked at Enron who wish they had never owned a single share of Enron stock. Each person is different, but understanding your specific situation and the risks and rewards of your employer stock can help you come to the right answer.

 

 

Don’t Make These Common Investing Mistakes With Your 401(k)

March 17, 2016

In our CEO’s new book, What Your Financial Advisor Isn’t Telling You: 10 Essential Truths You Need to Know About Your Money, Liz Davidson writes about how the best place to invest your money is often where you made that money: your workplace. While most people generally understand the value of contributing to their retirement plan, there’s a lot of confusion about how they should choose investments. Here are the biggest mistakes I see people making: Continue reading “Don’t Make These Common Investing Mistakes With Your 401(k)”

5 Ways to Save for Retirement With Some Surprising Benefits

June 13, 2013

When it comes to saving for retirement, most people know to contribute to their employer’s retirement plan (at least enough to max out their employer’s match) but there are also other ways of saving for retirement with some unique benefits that are not quite as well known. Here are 5 that you want to take advantage of if possible: Continue reading “5 Ways to Save for Retirement With Some Surprising Benefits”