What kind of compensation do you receive from your employer in exchange for doing your job?
You might just say, “my paycheck,” but that’s probably not the only kind of compensation you receive. Your company benefits count, too — and can do a lot to help your personal bottom line.
Your benefits, for example, might include health insurance policies that are far cheaper through your employer than the coverage you could buy on your own. Your benefits might also include other perks, like stipends or reimbursements for certain kinds of spending.
And you might have access to some kind of retirement plan, like a 401(k) or SIMPLE IRA, that comes with a matching contribution to your employer. This is where you can really leverage the perks of your job to grow your wealth.
Another way to do just that? Depending on your job and company, your compensation package might, at some point, include employee stock options, restricted stock units, or some form of incentive plan.
If you have access to these benefits — or your employer just made these available to you — and you’re wondering how to make the most of them, read on.
What Are Employee Stock Options?
When you have employee stock options, it means the company is giving you the right to buy a certain amount of company stock at a set price by a specific expiration date. That price is called the grant, exercise, or strike price.
The date the stock becomes available to you is the issue date, and the grant price is usually the same as the market value of the stock on that issue date (although it can be higher or lower, depending on the company and the specific type of option).
You may not be able to exercise your options on the issue date. There’s another date, called the vesting date, that determines when you can actually buy and sell company stock. In most cases, your options “vest” 3 years after the grant date, and then you have 7 years to exercise before the options’ expiration date.
You’ll also want to know if you have ISOs or NQs. ISOs are incentive stock options and NQs are non-qualified stock options. There are some differences in the limitations on each and how they’re taxed, so be sure to understand which you can access before you exercise any options.
Why Employee Stock Options Offer Opportunities to Grow Wealth
The reason all this is something to get excited about if you have access to stock options? The grant price on your stock options doesn’t change, even if the market value of the stock increases.
That means that during your exercise period, or the amount of time between the issue date and the expiration date of your stock options, you can earn a significant amount of money in addition to your salary because you can access company stock for less than what you can turn around and sell it for.
Of course, this comes with a lot of risk. There’s no guarantee the company’s stock price will rise now or in the future — and in fact, it could drop.
If you purchase a lot of options and the company’s value falls, you could risk selling your shares for less than you paid.
For this reason, it’s critical that you have a smart strategy when it comes to exercising your options
You should put this plan in place ahead of time, and know whether you’ll buy and hold (and if so, for how long), if you’ll buy and sell (and if so, how much), or use another strategy.
Stock Options Versus RSUs or Incentive Plans
Have restricted stock units (RSUs) or access to an incentive plan instead? You can still leverage these benefits to work your wealth. Here’s what you need to know, and how to leverage them.
Like stock options, RSUs also have vesting periods in which you’ll have to wait to do anything with them. Unlike options, RSUs aren’t a “right” to buy company stock. They’re units that you can exchange for company stock.
RSUs also come with less risk, since they’re units that allow you to receive shares of stock. This means you’re not buying in; you’re just using one of your units to receive one share of stock.
The company’s value can still go down, but that only reduces the size of your benefit. It doesn’t put you in a position of losing money, like a stock option can if you buy for more than you’re later able to sell for.
Incentive plans are pretty much what they sound like: ways for a company to incentivize you to reach higher levels of performance that are in turn profitable for the company. When you reach a certain goal or benchmark, you’re rewarded (and thus incentivized) for your efforts.
Other incentive plans include different types of profit-sharing and bonuses or commissions, but incentives could also include specialized training and education.
The logic behind incentive plans that if you know you hold company stock or could receive a portion of the profits, you’ll be motivated to do your part to increase the company’s value.
If every employee has this mindset, there’s a good chance that the collaborative effort of every worker’s best effort will increase productivity — and profitability.
What to Do with Your Options, RSUs, or Incentives
When I have clients with incentive plans, I tend to suggest take action immediately upon vesting. Then, we earmark a certain amount of the money earned from the sale for short term capital gains tax.
Once taxes are accounted for, we can use the net proceeds towards an important to-do in the client’s financial plan, like paying down debt or saving up for a home payment. These awards are really great to leverage when you’re working towards a specific financial goal.
Here’s an example of what you could do with your own incentive plan:
Let’s say on January 1, 2014, your company issued employee stock options that gave you the right to buy 1,000 shares of the company’s stock at a price of $15.00 a share. You have until January 1, 2024 to make those purchases if you want to.
Now let’s say that on March 1, 2017, your company stock reached $25.00 a share and you decide to exercise your employee stock options.
To recap so far:
- Your grant price is $15.00 a share
- The current market price is $25.00 a share
- Your issue date is 1/1/2014
- Your exercise date is 3/1/2017
- Your expiration date is 1/1/2024
To exercise your stock options you must buy the shares for $15,000 (1,000 shares x $15.00 a share), but then you could sell them for $25,000 (1,000 shares x $25.00 a share).
You’d have a profit of $10,000, but would need to set aside for short-term capital gains taxes before utilizing the gain towards any goals.
All these benefits can get really complicated, really fast, thanks to the tax ramifications of exercising, selling, or profiting from your company’s stock or incentive plans. You really need to understand the financial consequences of every action you consider taking before you make a final decision.
Stock options, RSUs, and incentive plans provide you with a path to build your wealth outside of your normal compensation from your paycheck — but they also carry the potential to do serious damage to your financial plan if you’re not careful about how you use them.
If you have employee stock options or other unique benefits, it’s smart to reach out to a financial planner who has expertise in helping people in the same position and with expertise on these specific compensation packages.