Wiser Financial Advisor – Overseeing Company Equity Awards
Hi everyone, welcome to the Wiser Financial Advisor show with Josh Nelson, where we get real, we get honest and we get clear about the financial world and your money. This is Josh Nelson, founder and CEO of Keystone Financial Services. Let the financial fun begin!
Josh: Today Jeremy Bush and I will be talking about overseeing the equity awards offered by your company. We are wealth advisors, Certified Financial Planners. So, “equity awards” means your company is giving you a piece of the company. You’re getting to participate in company profits and success, hopefully. So, we’re going to unpack that and dig into the details.
I’d say the majority of our clients that are still working are employed by a big Fortune 500 company, and they’re getting some benefits from that company. In a lot of roles, people do get stock options or stock awards, things that maybe not everybody gets. So that’s why this is particularly important because it can be a bit confusing if it’s something you haven’t had before.
Jeremy: They can be a pretty big boon to your retirement scenario, depending on how they go. And they definitely have tax impact that we will uncover for you.
Josh: Yeah, so if you’re getting equity awards, it probably means that you work for a fairly large publicly traded company and there’s some type of plan they’re offering you, and variations of that. So we’re going to talk about the different things that you might find yourself getting or you might get in the future. If not now, maybe you get a promotion. You pop up a level into a VP role or manager role or something, and now you’re starting to get those awards, which can be pretty substantial.
Equity awards can be very rewarding, though not if your company doesn’t do well. So there is risk. Clearly, there’s going to be risk involved and so everything we talk about today as always is just our opinions based on our experience as financial planners. We’ve got lots of clients that end up with equity awards and need to manage those. So this is something that we are well versed in.
Equity awards are a significant way for companies to incentivize their employees. In fact, many of our clients made much more money in their careers by the equity awards they received than what they got in compensation from their salary and bonuses. So it can be a substantial wealth creation tool for the employee. And from the company standpoint, it could be good too, because you’re giving your employees skin in the game. For huge companies with tens of thousands or hundreds of thousands of employees, it’s a way that the employees can participate in the company’s success. It also gives exposure to the stock market because we are talking about a stock that will react with the stock market. So it does give exposure to the stock market and the company sector.
Jeremy: These types of thing get called “golden handcuffs” because depending on the timing of vesting, you can be getting close to retirement and say, “Well, I really want to hang on for that next vesting. How much money am I going to leave on the table if I leave now versus if I wait six more months or another year?” So it’s the fear of missing out. People think, “I don’t want to pay the taxes,” or “I’m sure the stock is going to be higher in the future.”
Josh: Yeah, if the company stock has been doing well and continues to do well and keeps doing well, sometimes we get rolled into thinking that if something’s going in a particular direction, it’s going to continue going in that direction forever.
Jeremy: And when people have enormous equity awards, those positions build up and they become such a big part of your portfolio that it can be detrimental to your portfolio if something happens to that particular company.
Josh: There is a lot of individual company risk, and then market risk. You could be working for the best company in the world and if the stock market crashes, your company stock is probably going down too. So, we don’t want to keep all your eggs in one basket. Stocks could go to the moon or go the opposite direction. I’ve seen plenty of examples of that over my career. I’ve been doing this since 1999. That was kind of the end of the stock market dot com bubble. And of course, lots of dot com stocks don’t exist anymore. Look at the companies like Enron, Worldcom, Sears, Eastman Kodak, companies that used to be at the absolute top of their game. People would say they’re way too big; nothing’s going to happen.
Think about General Motors. Those of you who have entered the market more recently might not know that back in the financial crisis of the 2000s, General Motors went bankrupt. United Airlines in the early 2000s went bankrupt. Do those brands and companies still exist? Yes, they actually do. But if you had been the stockholder of one of those companies, you would have ended up losing every penny. You would have gone to zero, as far as value. So sometimes it’s not even that a brand disappears completely. It could be they just they go bankrupt, then go through some struggles and get reorganized. No one stays on top forever, even if you work for the best company in the world for a long time. Companies can be successful for decades, have a lot of profitability, but ultimately they won’t last forever. And you don’t wanna get stuck holding the bag when things aren’t going well.
Jeremy: That starts the cycle of market emotions that equity awards can play into. “I’ve got all these awards and the company’s doing really well. I don’t want to miss out if it goes higher.” Or thinking when it goes down, “It’s going to go back up. I’m sure it’s gonna go back up.” It really is just a roller coaster of emotions, and probably the hardest thing for people to do on their own is to be objective about the emotions of all this.
Josh: And there’s also fear on the downside. You’re looking at maximum pessimism when you’re talking about the bottom of the financial crisis or the bottom of the dot com crash or 9/11. And times when the market went down a lot very quickly. Think about the pandemic. The stock market dropped about 30% within weeks of the pandemic hitting. It certainly can happen. And so the tough part about the cycle of market emotions is that it makes you want to buy more and take on more risk when prices are high. It’s that recency bias of thinking: “Yeah, the stock market’s going up, and it’s going to continue to go up forever.” Same thing on the downside when things are looking terrible.
The reality is, when it’s so bad, that’s usually the best opportunity to buy—but nobody wants to at that point. It doesn’t feel good. So it’s helpful to have a Financial Planner that’s not you, to give you advice that’s in your best interest, so you’re not just stuck in your own head and making those decisions at those critical times.
Jeremy: RSU’s are Restricted Stock Units. These are probably the most prevalent out there, mainly because this is how companies can really get a buy-in. They can give you the awards, but these vest over a specific amount of time, so it’s not that they’re giving out the stock and then the next day you can turn around and sell it. This is the golden handcuff situation. Because no matter when you leave, you are ultimately leaving money on the table with most companies.
Josh: It’s more the exception, but there are some companies with a policy that if you reach a certain retirement milestone, they’ll let you vest them in that retirement. But that’s not common. Usually, if you leave, the money’s gone at that point, whatever you haven’t already received.
Jeremy: The keys to these are a) grant date, which is when the shares were granted and b) vesting period, which can be anywhere from quarterly to annually. It’s up to the company. Most of the time what we see is either quarterly or annually. If they give you say 1000 shares at quarterly vesting, that means pretty much evenly every quarter you get 250 shares.
Josh: Yeah, it seems like a lot of the companies that our employees or our clients work for have that quarterly, which is a wonderful problem, but sometimes people have a hard time retiring because it’s so much money you’re leaving on the table. Well, your company knows that. They’re trying to keep people from leaving because, especially in today’s market, the unemployment rate among engineers, professionals, highly skilled people, is very low and it’s hard to get employees to switch companies.
Jeremy: The important thing to remember on these is that they are taxed typically when they become unrestricted or when they vest. Not always, but most of the time what happens is the company will withhold a few shares to pay the tax. It shows up on your W2 and now all of a sudden you have these shares. I’ve run across a company or two who did not do the withholding shares and then you were stuck with the tax. So it’s important to know what your company’s policy is on this and how that works.
Josh: Yeah, usually you can tell from your pay stub. That’s the best evidence we can look at to see what’s happening. The biggest thing here is making sure that you don’t have a big tax surprise. Nobody likes to get to tax time and all of a sudden they owe thousands or tens of thousands of dollars they didn’t expect. There is a lot of tax planning with our clients, especially as you get into higher income brackets and more complexity in your situation. Often, when people haven’t optimized their planning, they’re kind of winging it, which could mean paying unnecessary taxes or having unnecessary stress.
Jeremy: So, say we got a share on January 1st, a grant is what it’s called, and it’s on a four year vesting schedule. That means every year for four years you get 250 shares that vest or they become yours on that January 1st date if it’s annually. In this example, it’s annually. So with any kind of equity we have three 3 main dates:
The grant date.
The vesting date.
The sale date.
With RSU’s, that vesting date is important because that is when those shares become yours. When those shares become yours, they typically do withhold a few shares to pay your taxes. But then all of a sudden, now you have shares that are out there. They’re live, and they’re yours to do with as you wish. At that point, you have some options. You can say, “I’m immediately going to sell and get no further tax consequences.”
Then again, a lot of people say, “I’m going to hang on to these shares. The company is doing really well.” So they’ll hang on to those shares and then it becomes a matter of capital gains. People come to us all the time with shares they’ve been hanging onto for years. A lot of times it works out great for them, but they have some big capital gains. And anytime capital gains enter the situation, you really have to look at the short term versus the long term. By short term, we mean 366 days or less. If you sell it from the date of that vesting, that’s going to be a short term capital gain that’s taxed at your highest tax rate of 20%. If it’s 366 + 1 days, it’s considered long term, which for most people is typically a flat 15%. Plus state taxes, sometimes even city taxes, to pay where you live.
Josh: Clients who aggressively go after additional RSU’s can find themselves in the situation where they have an awful lot of their net worth exposed to just one company. Often, we’ll recommend that the second those shares become unrestricted, sell them right away because there’s no tax advantage in hanging on to them. At that point, you’ve already paid the taxes. If you’ve got a quarterly vesting schedule, you know the stock you have will be unrestricted in a few months. Often, it can take the emotion out of it, if you sell as soon as it vests. Then you can take it, diversify it, pay off debt, whatever you need to do in your own financial situation.
Jeremy: Some people think (when receiving the vested stock), “Hey, this has nothing but upside to it.” Then we explain that because this is such a big chunk of your portfolio, it’s almost unhealthy. Then we advise them to come up with some kind of schedule to peel this off in a tax efficient manner. It’s really about tax management.
Josh:, Yeah, make sure you understand the rules. People end up making mistakes or have unexpected surprises just because they didn’t understand the rules or how things work. For sure, most companies are using RSU, so that’s why we spend so much time on it.
Jeremy: So, the non-qualified stock options are probably the more simple of them. There’s no real vesting date. Basically, you get some option to buy but you don’t have to buy if you don’t want to. You have an option to buy. Usually, there is a discount associated with it, so you can buy the shares for a deeper discount. Typically, you buy and then sell immediately. You don’t have to sell, but those three dates and three prices are in play here. The grant, the exercise (which means you purchase the stock at the price set by the option) and the sell date.
Josh: And there’s that golden handcuffs element of this: most of the time if somebody leaves their company, their stock options are worthless—they aren’t able to be exercised. Depending on your circumstances, you may have a certain period of time or maybe at retirement it would give you a certain period of time, but there’s a particular risk here because with stock awards, when you receive the shares of stock, if it happened to be in the bear market or something like that, you could hold on, wait and hope they come back up. With stock options, there is that expiration date. That’s a big risk—running up against that expiration date. Does your company stock happen to be down? I saw that happen a lot over the years with people. They were waiting, waiting, waiting. And they waited until the last month before the expiration, the stock was way down and then it’s either worthless or worth a lot less than they would have had.
Jeremy: With the non-qualified stock options, we still have the grant price and date. We have the exercise date and we have the sale date. When these get exercised (bought at the price set by the option), there’s the dollar cost of the difference between the grant price and the exercise price. Usually the exercise price is at a discount. When you exercise the option and you say “Yes, I’m going to buy these options, I’m going to fulfill them,” there’s that bargain element or that discount price. When you exercise that, whatever that discount may be, it is immediately considered ordinary income. And then before it becomes a capital gain, you can immediately sell right then and there. And if you’ve bought at a discount, then automatically those shares are worth more than you bought them for. But then if you do choose to hold them, you’re still going to be subject to short term capital gain if you hold them for under a year. So it’s a matter of timing.
Josh: The thing that RSU’s and non-qualified stock options have in common—they’re both taxed as ordinary income when it becomes available, which is when the exercise happens. That’s called a cashless exercise, when somebody decides to buy and sell right away. Usually employers or whoever they’re using—Fidelity or Schwab or something to administer their stock plan—will have that lined up so you’re not actually having to send money. It’s instantaneous.
Jeremy: The next topic is Incentive Stock Options (ISOs), which do still exist. These are by far the most complicated of all of the equity awards, because there are some serious tax implications. ISO’s are rare. Typically where you see these is in brand new companies that are up and coming. They want to incentivize their employees to hang around and have some ownership in the company and push the company forward. But maybe they don’t have the ability or the cash flow to give non-qualified stock. There can be some tax advantages to these, but again it comes down to timing and the other important part of this is alternative minimum tax implications as well. So these can get complicated quickly, but we’ll try to give you a quick overview. Honestly, I will tell you right now, anybody that does have incentive stock options—you probably already know you need help with them. Talk to somebody like us, because it’s gonna take somebody like us to give you the dollars and the numbers associated with what they mean.
Josh: If you’re our client, you’re paying us, and then we can actually recommend to give you advice. But this is all general information, not advice to you personally.
Jeremy: Time is an essential part of ISO’s. We have the same three pieces. We have that grant date, exercise date, and sale date. That bargain element—which is the difference between the grant and the exercise date and the prices involved with each—is subject to alternative minimum tax when they get exercised. In order to take full tax advantage of an ISO, you have to have the exercise date one year from the grant date and then the sale date 2 years from the grant date or an additional year past that exercise.
Josh: Yeah, there’s some critical time frames here in buying the stock. In this case, there would be a tax advantage potentially to buying a stock and holding it.
Jeremy: So things like alternative minimum tax get involved in that first year. If you end up not meeting both of those timelines, (and it’s not one or the other but both timelines), that’s called the disqualifying event. Then everything gets counted as ordinary income. The IRS is really good at catching that one, but yeah, it’s the difference between that bargain element being counted as ordinary income versus all of it getting counted as capital gains, which can be substantial, especially if you’re in a high tax bracket.
Josh: I’m gonna fly through a couple more of these. Many publicly traded companies will offer what’s called a stock purchase plan or stock ownership. And so you’ll probably be aware of that in your benefits package if it’s there. It gives you the ability to buy into the stock, so it’s not being given to you like with the options and the RSU’s. It means that you can buy it and not always at a discount. Sometimes it’s just a convenient way to have it taken out of your paycheck, but more often than not, we’ll see anywhere between a 5 to 15% discount your company is giving you on the stock price. If the stock just breaks even or goes up slightly from what you bought it at, and if you’re able to buy at that discount, it could become a substantial amount of money.
Jeremy: Yeah. And next to the RSU’s, this one’s probably the next most popular. You sign up for it. Most companies do this quarterly and then once a quarter they take some money out of your paycheck.
Josh: This does get treated as capital gains with the bargain element of any discount that your company was giving you.
Jeremy: That bargain element is dependent upon that discount. If it’s anywhere in that 5 to 15 percent that we typically see, that gets counted as income at the time of purchase. It’s an immediate thing. It’s an immediate ownership.
So, a hypothetical stock that’s trading at $10 this year—we’ll just say that fair market value is $10 a share. If you get a 10% discount, you’re buying it at $9 a share. They gave you a buck, so you get a $1.00 bargain element. You don’t get taxed on that when you initially buy these shares, so that just kind of hangs out. It’s on the books for a while.
Josh: And in this stock purchase plan versus some of the other things we’ve been talking about, everybody can participate. If you’re listening to this presentation and thinking, “RSU’s, options, what are you guys talking about? I’ve never been offered that,” it’s because not everybody usually gets that, only those in certain positions. So the company can discriminate versus the 401K. There are certain things that everybody gets to participate in. These are kind of special benefits that again, if you have them, it’s a great problem, but it’s something that you may not have faced before. Maybe you started at a lower level position within the company.
If we did a series called Financial Planning Horror Stories it would include underwater stock options. These days, especially as technologies get better, companies like Fidelity have gotten better at not letting you screw up, but underwater stock options is an example of how you could screw up stock options exercises.
Jeremy: Yeah. So again, it’s an option; you have the option of buying. You don’t have to. Now, what makes an underwater stock option underwater? If the exercise price is higher than what you can buy that stock for on the open market, it’s called underwater. So basically you’d be paying $10.00 for a stock that’s worth less than that. Which makes no sense, of course. If you’re gonna buy it, you might as well just go to the open market and buy it.
Josh: If your options are worthless, they’re underwater. And if they’re coming up against their expiration date, sorry to inform you: they’re just gonna expire worthless. They’re gonna expire underwater, but that’s a lot better than exercising underwater options and paying out money to lose that money.
Jeremy: And you might think you can just take a tax loss , but the exercise itself does not actually qualify as a as a tax loss. So you would literally have to buy the shares at the high price and it gets really messy. It’s just not worth it.
And this is the prime reason why we diversify. No one can tell you which asset class is going to be at the top or the bottom of returns next year. It’s just how the chips fall. We own a little bit of everything so we can smooth things out.
Josh: That brings us to asset allocation which is our fancy way of saying, “Don’t put all your eggs in one basket, and make sure that wherever you’re investing your money, it’s at a speed limit that’s appropriate for you and what you can actually tolerate.”
Jeremy: This market stuff will swing by the hundreds of points from day to day, and it will drive you nuts. It’s important to find the asset allocation you can live with. If you have that long term vision and long term plan, you can take the rest of it.
Josh: Yes, it’s important to understand what you can tolerate, so you’re not faced with pulling money out when things are way down. If you go to our YouTube channel, you’ll see some of these on the replay showing the average rate of return on different types of portfolios. Conservative would be about 5%, aggressive would be about 10%. It’s a big difference. But the worst 12 month return of a conservative portfolio is down 17 versus down 60 on an aggressive portfolio. So a bad year can be really bad when it comes to an aggressive portfolio. Now it should be said nothing is guaranteed. But for somebody that put money into an aggressive portfolio during a really bad year like 2008 or 2020, if they had hung on and if they were diversified, they would have gotten their money back. Even the worst market downturns don’t last forever.
Jeremy: But sometimes, it does take time. So if you’re looking at a period between 2008 and how long that took to come back versus 2020 or even 2022, you know how quickly those bounce back.
Josh: Our friend Sir Richard Branson says, “Complexity is your enemy. Any fool can make something complicated. It is hard to make something simple.” And the reality is, a lot of this stuff is complicated, and we didn’t make the rules for the tax code or the estate planning code or other things we deal with all the time. When you are in a position where you’ve got to make decisions, you definitely don’t want to leave money on the table. You want to make sure you’re taking the best of what you can and that you understand the rules.
We’re here as a resource. We certainly love working with our clients and this is what we enjoy every day as things change over time. People’s lives change, the economy changes, the market changes, the tax code changes. We’re in the trenches every day. We’re real people, real financial advisors. We’re not AI robots. And we’re glad you’re here. Feel free to email me: email@example.com or Jeremy: Jeremy@keystonefinancial.com Our website is www.keystonefinancial.com .
Have a wonderful week and God bless.
The opinions voiced on the Wiser Financial Advisor show with host Josh Nelson are for general information only, and are not intended to provide specific advice or recommendations for any individual. To determine what may be appropriate for you, consult your attorney, accountant, financial or tax advisor prior to investing. Investment advisory services offered through Keystone Financial Services, an SEC registered investment advisor.