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This is proverbially known as the golden handcuffs. Leave the company before your employee stock options vest or before you have the right to act on your option , and you run the risk of forfeiting the potential value of said employee stock option. Remain with the company until the options vest, and you may be rewarded with the ability to buy shares of company stock via the employee stock option at a price lower than the current share price.
In many instances, there may not be many decisions with pre-vested stock options. Once employee stock options vest, however, there is a real decision that may need to be made. A decision that might have a material impact on your financial plan, income tax, cashflow, and investment risk profile. Employee stock options are provided as part of a compensation package.
But options are very different from typical cash compensation. Holding employee stock options means you have the right to purchase shares of company stock at a predetermined price called the exercise price sometime in the future. That sometime in the future is known as the vesting date. Before reaching the vesting date, the recipient of the employee stock options often has no right to exercise the shares even if the share price of the stock appreciates above the exercise price.
After the vesting date, you need to ask yourself if you want to continue to hold your employee stock options and shares — or should you exercise and sell the shares, taking the value and redeploying it into other assets? If you want to hold the company stock, the decisions may become more complicated. You can continue to keep the unexercised employee stock options as is. Or, you can exercise the employee stock options and hold the shares. Depending on the type of options you have and your appetite for income tax and investment risk, the outcomes can be varied.
This is often a strategy that may be implemented by employees seeking to treat the value of employee stock options as if it were the same as their regular paycheck. It may also include paying cash for the pending tax liability if any. Depending on the value of your employee stock options and the type of stock option you exercise, the cash required to exercise your employee stock options can be significant. A cashless exercise typically requires no cash outlay to exercise your employee stock options.
When you exercise, a portion of the shares are exercised and held and a portion of the shares are exercised and sold. The proceeds from the sold shares are specifically used to pay for the cost of the shares themselves and possibly some or all of the pending the tax liability. There is not often a perfect answer as to what is a better option, a cash, or a cashless exercise. The better solution is the one that allows you to meet your personal financial planning goals and objectives. As mentioned above, exercising your options might trigger some tax consequences. In addition to the regular income tax of which you may be aware, you might also need to pay the alternative minimum tax or AMT.
When you exercise incentive stock options, the value between the exercise price of the option and the fair market value at exercise is an AMT preference item known as the bargain element. Depending on the size of the bargain element, you may be subject to paying the alternative minimum tax. As you can see from the simple example, the larger the bargain element, the larger the possible tax bill. However, our example is simplified for illustration purposes, and your figures may be different.
A good accountant or financial advisor may be able to help you explore what your potential alternative minimum tax may be. If you find a large portion of your net worth is allocated to company stock, it may be a good time to consider reallocation some of your employee stock options to another asset.
are a form of compensation. Companies can grant them to employees, contractors, consultants and investors. These. › investing › how-do-stock-options-work.
Additionally, you may want to consider how much of your financial health is tied up in one company. Your job, your income, your benefits, your social circle, and your net worth are a sizeable part of your life.
What happens if the said company takes a turn for the worse? Are you comfortable having all your eggs in one basket? Selling some or all of your employee stock options may help eliminate concentration risk. Concentration risk not only when evaluating your position in a single stock, but also concentration risk when considering your overall financial wellbeing. Employee stock options can be a fantastic opportunity to generate increase wealth under the right circumstances.
However, with great opportunity comes great responsibility.
The content herein is for illustrative purposes only and does not attempt to predict actual results of any particular investment. None of the information in this document should be considered as tax advice. You should consult your tax advisor for information concerning your individual situation. The sense of shared ownership can foster a strong corporate culture. Employees literally help to grow the company not just as staff, but as shareholders. For employees, stock options can result in tremendous wealth, particularly if you join the company at an early or growing stage.
On the flip side, those are the companies that are also likely to go under with only worthless stock options left behind. Stock options have expiration dates and will be worthless if held too long. But deciding when to exercise before the options expire can be difficult as well.
One camp says hold out as long as you can, waiting for the pinnacle price. On the other hand, you may risk waiting too long and miss the peak, or else exercise too early and miss more growth. There is no right answer.
The circumstances will depend on your company, the market, or any number of things that you may not be able to predict. All else being equal, stock options are generally a great perk. If you accept a job with stock options, it is helpful to ask the human resources representative if there is any guidance or advice to help sort out stock options for employees. The information contained in this article is not legal advice and is not a substitute for such advice.
Table of Contents Expand. Table of Contents. What Is a Stock Option? Types of Stock Options.
By Melissa Phipps. The Balance Careers uses cookies to provide you with a great user experience.