Webinar in Review: Stock Option Optimization

Contributed by: Emily Lucido Emily Lucido

If you have non-qualified stock options, restricted stock units, or incentive stock options but don't fully understand them, you're not alone. What exactly are stock options? Why do employers offer them? How do they factor into your overall financial game plan? In a recent webinar hosted by Nick Defenthaler, CFP®, he answers all these questions in a simplified manner and discusses what it could mean to be offered a stock option from your employer and how to go about maximizing them.

Employee stock options can be an incredible add-on to employee compensation. Typically, those that are eligible are people within a higher level executive position at their workplace, or are with a startup firm. In most cases, employers use stock options as a way to attract, retain, and motivate employees which can then potentially drive up the company stock price.

What is vesting?

One very important part of stock options is the vesting schedule. Every company has a different structure for vesting. The vesting schedule can depend upon a variety of things including the company you work for, as well as, your position at the company. The chart below represents a three year vesting schedule:

In the above example, each year, you receive 33% more of the stock options, ultimately leading you to year three where you end up with 100%, having access to all options (which is where the incentive to stay with your employer comes in). So, if you were to leave the company in year two, you would only end up with 67% of options vested.

What are the most popular forms and how do they function?

  • Non-Qualified Stock Options (NSO)

    • A written offer from an employer to sell stock to an employee at a specific price within a specific time period

    • With NSO’s the market price has to be greater than the exercise price for the option to have value

      • Can be seen as a more risky form of equity compensation

    • Tax implications: when you are granted or “given” stock options, there is no tax

      • If you exercise those options there could be a taxable event if there is a gain

      • The gain is taxed as ordinary income, as a form of “compensation”

  • Restricted Stock Unit (RSU)

    • Similar to NSO’s, RSUs are a written offer from an employer to sell stock to an employee at a specific price within a specific time period

    • Main difference: As long as the company stock has value there will be value in your stock option. It is not determined by the market price as NSO’s are

      • Can be seen as more conservative form of equity compensation

    • Tax implications: Same as NSO’s - when you are granted or “given” stock options, there is no tax liability

      • Tax is due upon vesting

      • Also taxed as ordinary income, as a form of “compensation”

      • In most cases, we recommend selling the shares of RSU once they vest, in order to reduce risk and to diversify

An important note when thinking of stock options and whether to exercise or not:

“Don’t let the tax tail wag the investment dog.”

  • Simply put, don’t let taxes be your only reason for deciding whether to exercise or not

  • If you choose not to exercise because you are worried about the tax implications, the stock could easily go down in price, losing the potential gain you could have made

Overall, stock options have many benefits to them and can be extremely valuable when used effectively. There are many more opportunities you can take advantage of, so take a moment to listen to the webinar below as Nick goes into more detail on what you can do to effectively manage your portfolio when considering your stock options.

Emily Lucido is a Client Service Associate at Center for Financial Planning, Inc.®

This information does not purport to be a complete description of employer stock options or employer stock option planning strategies, and should not be construed as a recommendation. This information has been obtained from sources considered to be reliable but we do not guarantee that it is accurate or complete. Opinions expressed are those of Emily Lucido and are not necessarily those of Raymond James. While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional.