RSU and Options Planning
by Dennis Doble, CFP
- Characteristics of compensation packages
- Important considerations when holding company stock in your portfolio
- Have a plan in place to minimize taxes when selling stock
Does your compensation package include options, restricted stock units or restricted stock awards? Are you able to participate in an Employee Stock Purchase Plan? These types of compensation can greatly enhance the value of your overall compensation package. They can also produce some headaches when it comes to understanding the details of each type of compensation and the best way to turn them into future dollars. Having a plan in place can help minimize future taxes and prevent you from relying too much on one company for both your income and your investments.
These types of compensation are based on the idea that by giving employees an interest in the performance of the company, they will be motivated to positively contribute to its success and its stock value will continue to increase over time. If this does happen, when it is time to sell company stock, the employee could potentially see significant capital gains, which will produce capital gains taxes. Here is where the value of planning can have a big impact on your bottom line.
TYPES OF COMPENSATION
With stock options, the employee is offered the option to buy shares of company stock at an agreed upon price called a strike price at a future date called a vesting date. This category can include non-qualified stock options (NQSO) and qualified, or incentive stock options (ISO). The difference between the two is that for ISOs, the employee must hit certain performance targets in order to receive the options, where there is no such requirement for NQSOs.
RESTRICTED STOCK UNITS
Restricted stock units are shares of stock that are granted to an employee as of a certain date known as the grant date. The employee has an interest in the company but does not own the shares until the date known as the vest date. On the vest date, the employee automatically takes ownership of the shares at their fair market value and the value of the shares becomes income to the employee.
RESTRICTED STOCK (AWARD)
Similar to the RSU, a restricted stock award is also granted to an employee, the shares automatically vest on a specified date, and the value of the shares becomes income to the employee. Unlike with an RSU, a tax planning opportunity exists for Restricted Stock Awards called an 83(b) election. If the value of the stock is expected to rise significantly during the vesting period, an 83(b) election allows the employee to choose to pre-pay the taxes on the stock as income on the grant date to avoid paying more taxes later on the vesting date. There are many factors to consider before making this election and once it is made it is irreversible.
EMPLOYEE STOCK PURCHASE PLAN
An Employee Stock Purchase Plan (ESPP) allows an employee to purchase stock in the company at a discount through regular payroll deductions. During the offering period, funds from payroll deductions accumulate until the purchase date, at which point shares are purchased and the employee immediately owns the shares.
CONSIDERATIONS ONCE YOU OWN COMPANY STOCK
Depending upon the amount of options you exercise and grants that vest over time, you could have a significant portion of your investment portfolio in the stock of just one company, which introduces certain risks to your financial picture.
- Risk of a concentrated position. A good rule of thumb: if your company stock represents more than 20% of your overall portfolio through the exercising of options, vesting of restricted stock, or subsequent capital appreciation, consider selling some of your position to lower your exposure.
- Risk of financial and income life tied to one company. If both your income and your investment portfolio are relying on a single company for cash flow and capital appreciation, this exposure puts you in a risky position should something go wrong at your Employer. You might consider diversifying your portfolio to reduce this risk.
- Advantages of a diversified portfolio. Investing in different industries, geographical areas, and company sizes spreads out your portfolio risk, protecting you as an investor from the up and down swings of any one company.
TAX CONSIDERATIONS WHEN SELLING
Having a strategy in place for the sale of your company stock is of great importance to making the most of your investment. Taxes can erode much of your gains when it is time to sell your shares, but with some thoughtful planning in place, taxes can be minimized.
As an example, Jane Doe is in the 37% income tax bracket and falls into the 15% long term capital gains bracket based on her $150,000 salary. Look at the following chart for one example of how timing the sale of company stock can impact her tax bill.
By choosing to hold her shares for a full year after exercising her options, Jane saves $1100 in taxes. If Jane is married with a working spouse, it is possible she may be in an even higher capital gains tax bracket which would result in the opportunity for even greater tax savings. When you combine planning strategies such as this across multiple types of compensation and in greater numbers of shares, the savings really add up.
RESTRICTED STOCK UNITS
Unlike stock options, with RSUs you don’t have control over the timing of income taxes. Every time your shares vest, you pay taxes and immediately own the shares. Since you have no control over the timing of these events, it is important to have a disciplined sell strategy in place. At each vesting date, review your overall portfolio and make a thoughtful decision to hold or sell the shares based on your new concentration of company stock. This reduces your risk of a concentrated position, gives you some control over taxes, and is a relatively easy task to perform at each vesting date.
This article is intended to present you with overall considerations for getting the most value from your workplace compensation plan. There are many factors to consider when determining a strategy for owning and selling company stock. As with any financial strategy, please do your own due diligence and talk with your advisor or CPA to determine the strategy that is best for you.
Do you have a question about RSUs and stock options planning that is not answered here? Click the button below to submit a question to Dennis.
About the Author
I am an avid gardener, a trait I inherited from my Sicilian grandfather. Herb, cucumber, spinach, lettuce, and tomato varietals fill my yard each Summer. I am the only person in my neighborhood bold enough to plant vegetables in the front yard (best sun). Get me talking about growing tomatoes and the conversation might never end. The garden is a special place for my two daughters and me. We chase each other around the eggplants, search for cucumbers hiding under the vine, dig for worms, and pluck tomatoes just as they show a tint of ripeness.