Stock options can be excellent wealth-building agents, and using them to the fullest helps you reach your financial goals. But with so much complexity surrounding these profitable “promises,” are you clear about how they work?
No matter the type of equity you have, you won’t be able to do anything with them until they vest. Vesting is like a green light, alerting you to make a move—exercise, buy, sell, hold, etc. You’ll have several options depending on the type of equity your company gave you.
When the vesting time comes, do you know your options and the best move for you?
Below I’ve identified five considerations before deciding what to do next with your stock options after they vest.
1. Understand What You Have
You may have several types of equity compensation, including ISOs, NSOs, ESPPs, and RSUs. The specific type can impact your choices before they vest. Let’s take a closer look.
ISOs, or incentive stock options, are employee-only stock option that allows you to purchase a quantity of stock at a specific price. In most cases, C-suite executives or high-level employees get ISOs. Early hires at start-ups may also run across ISOs.
It’s possible to exercise and hold to get more favorable LTCG tax treatment, but it is also risky because if you are not paying attention you could have a big tax bill without making any money. Make sure you know the potential pitfalls before exercising your ISOs.
NSOs refer to nonstatutory (or nonqualified) stock options. NSOs are similar to ISOs but with two primary differences.
First, a company can grant them to professionals outside of the company, like board directors or consultants. Second, they do not receive preferential tax treatment.
You may be obligated to pay taxes when you exercise the options and again when you sell the shares.
An employee stock purchase plan, or ESPP, allows employees to purchase company stock at a discount—up to 15% below market value. The employee elects to deduct after-tax dollars from their paycheck into the ESPP. At certain times of the year, your company purchases the stock at a discounted rate on your behalf.
Restricted stock units (RSUs) grant employees a particular number of shares in company stock, which they can access after a predetermined period.
Unlike other types of equity, once RSUs vest, you own them; you don’t have to buy or exercise the shares. So it’s helpful to think of RSUs as a “bonus.”
With single-trigger RSUs, you own the shares as soon as you meet the vesting requirement. But double-trigger RSUs require a second stipulation like an IPO or other event before you actually own (and can act on) the stock.
2. Familiarize Yourself With Company Requirements
Companies typically require specific holding rules, vesting schedules, or other stipulations before you own the stock. In some cases, like double-triggered RSUs, stock ownership may depend on your performance, product launches, or other company milestones.
- Is your company public or private? If private, are they planning an IPO soon?
- What is the vesting schedule for each type of equity? For example, your RSUs might be on a different vesting schedule than your ISOs.
- Does your company have unique requirements for your equity?
- What happens to the equity if you were to lose your job? Be sure you know when your options expire. For example, ISOs expire in 10 years.
It’s also important to understand what happens to your equity if you leave your job, especially if stock options were an important incentive when you signed on.
3. Know Your Goals Before Making Decisions
It’s easy to get an emotional attachment to your equity compensation. Is it foolish to leave a job when your equity is just about to vest?
The better question to ask is, “How does my equity compensation fit into my greater financial plan?” Instead of trying to dictate what you do based on a vesting schedule, decide what you want to happen and make a plan from there.
Are you hoping to hold some of your company’s stock in your portfolio? Would you use the profits earned to fund an important goal, like buying a house or building a college fund? Understanding your big picture can provide some perspective and direction on what to do next.
4. Maintain Realistic Expectations
When it comes to stock options, it’s far too easy to count your chickens before they hatch.
Here’s what I mean:
Your company may be on a hot streak now, but say your options don’t vest for another three years. By the time you’ve met the vesting requirements, your company could be in a completely different financial position. This is especially apparent after seeing what an unexpected event like Covid-19 can do to change the trajectory of a business.
As a rule of thumb, it’s best not to count on the money from your equity until it’s actually there.
5. Make a Tax Plan
Different stock options will have different tax ramifications. Each comes with holding requirements for favorable tax treatment and tax rules.
It’s important to know exactly what you have to prepare for tax-wise before exercising your stock options. Unfortunately, taxes can be a significant source of stress for employees with complex compensation packages, leading to procrastination and avoidance.
But bracing yourself with knowledge now is crucial, especially as a high-earning tech employee. In some cases, like RSUs, your employer may withhold some stock units to cover the cost of taxes. But it’s common for employers not to withhold enough, which can cause an unpleasant surprise when you need to sell stock to cover the remaining tax bill.
Familiarize yourself with how vesting may impact your taxes. While tax planning is an essential piece of your financial plan, it’s also wise to work with a tax professional like a CPA to help you fully understand your options.
What To Do When You’re Ready to Sell the Stock
When you’re ready to sell your stock, you will need to figure out how this move will impact your financial plan.
You may be selling for several reasons, like buying a home or diversifying your portfolio with a less risky investment. At this point, it can be challenging to make your next move. Developing an investment strategy on your own is overwhelming, and you may be intimidated to put that money into the stock market.
In other cases, people don’t ever sell their company stock because they don’t have a plan of action. They’re prone to suffering the consequences when a company’s good fortune goes south. That’s why diversification is important, as you don’t want all of your wealth tied into the success (or failure) of one company, which happens to be your employer.
I work with employees in tech who have questions about optimizing their compensation packages, including their stock options. If you’re preparing for your options to vest or wondering what to do next, I can help.
Reach out anytime, and I’d be happy to address your questions and discuss your financial goals.