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Prioritizing Financial Goals After a Windfall
Prioritizing Financial Goals After a Windfall
March 19, 2023
Key Financial Milestones
Key Financial Milestones You Should Be Hitting in Your 20s, 30s, 40s, 50s, 60s, and Beyond
April 20, 2023

Do You Need an Exit Strategy for Your Employee Stock Options?

Published by Anh Tran, CFP®, Esq.  on March 28, 2023
Do You Need an Exit Strategy for Your Employee Stock Options?

If you’re a high-earning professional or executive with non-cash compensation, you may need an exit strategy for your employee stock options.

With mass layoffs taking place within the technology sector and take-private transactions on the rise, many high-earning professionals and executives are facing complex questions about their employee stock options.

Indeed, stock options can be a valuable component of your compensation package—especially if you have the luxury of time on your side. But if you lose your job unexpectedly or your employer is the target of a buyout, you may have some complicated decisions to make.

Therefore, it’s important to have a plan for how you’ll manage your stock options if and when you leave your employer. An exit strategy can help you potentially maximize the value of your options and avoid unnecessary losses or tax consequences.

What Are Stock Options?

Stock options are a type of equity compensation that gives you the opportunity to purchase shares of your company’s stock at a predetermined price, known as the strike price. Many employers grant stock options to incentivize their employees to work towards increasing the value of the company’s stock, which in turn increases the value of their options.

But timing is also critical when it comes to stock options. Ideally, you can exercise your options when your employer’s stock price is at its highest. Meanwhile, you also need to consider the potential tax implications and the cost of holding onto the stock.

Here are four factors to consider when developing an exit strategy for your employee stock options:

Your stock options may not be as valuable to you if you and your employer unexpectedly part ways. To avoid costly missteps, it’s advantageous to have an exit strategy for your employee stock options—even if you don’t ultimately need it.

#1: Understand the Terms of Your Stock Options

First, make sure you understand the terms of your stock options, including the vesting schedule, expiration date, and strike price. Factors such as vesting schedules, expiration dates, and strike prices can affect the value of your options and your ability to exercise them.

It’s also important to be aware of any restrictions or limitations on when and how you can exercise your options. This information can help you develop an effective exit strategy for your stock options if you leave your company, lose your job, or your employer is acquired.

#2: Know the Risks When Developing an Exit Strategy for your Employee Stock Options

Employee stock options can offer significant benefits, but they also come with potential risks. Examples of these risks include:

  • Volatility risk. Employers typically grant stock options with a strike price that’s equal to the market value of the underlying stock at the time of the grant. If the market value of the stock falls below the strike price, your stock options may ultimately expire worthless.
  • Expiration risk. Employee stock options have a finite life, which means you must exercise them before they expire. If you fail to exercise your options before the expiration date, they lose their potential value.
  • Taxation risk. Stock options are typically subject to complex taxation rules. If you don’t have a clear exit strategy in place, you may face a significant—and unnecessary—tax liability.

Indeed, there are always tradeoffs when it comes to managing employee stock options. Even if you exercise your options at the right time, holding the stock can introduce new risks.

Thus, it’s important to weigh these tradeoffs carefully when developing an exit strategy for your employee stock options. That way, you’ll be in a better position to maximize your potential gain while minimizing the associated costs.

#3: Evaluate the Potential Tax Consequences

The tax treatment of your employee stock options typically depends on the type of options you have, your income level, and your state of residence. If you have stock options, you typically pay taxes at two points: when you exercise your options and when you ultimately sell the stock.

The two primary types of options in the U.S. are incentive stock options (ISOs) and non-qualified stock options (NSOs).

Tax Treatment of NSOs

When you exercise NSOs, the difference between the strike price and the fair market value of the stock is taxable as ordinary income. Employers typically withhold taxes, including federal and applicable state taxes as well as payroll taxes, on this spread at the time of exercise.

For example, suppose you hold 100 NSOs worth $50 per share ($5,000 total). You exercise your options when they’re worth $100 per share ($10,000 total).

The $5,000 difference is taxed as ordinary income when you file that year’s tax return. This boost in income may also push you into a higher tax bracket.

Tax Treatment of ISOs

When you exercise ISOs, on the other hand, the difference between the strike price and the fair market value of the stock is considered income when calculating the alternative minimum tax (AMT). AMT is a separate tax that requires some taxpayers to calculate their tax liability twice.

When you sell either type of stock option, you may have to pay short- or long-term capital gains taxes depending on whether you made a profit and how long you held the stock before selling.

Short-term capital gains apply to securities you hold for less than one year and are taxed as ordinary income. Meanwhile, long-term capital gains are typically subject to a tax of 15% or 20% depending on your income level.

Taxation of stock options can be complicated, and there are many factors that can impact your exit strategy and overall financial plan. Be sure to consult a tax expert or financial planner before exercising your options.

#4: Consider Your Long-Term Financial Plan

When developing an exit strategy for your employee stock options, it’s also important to consider how exercising your options may impact your overall financial plan. Aside from the potential tax consequences, you’ll want to consider the pros and cons of holding company stock.

One aspect to consider when exercising your stock options is concentration risk. Concentration risk is the risk of capital loss that arises from investing a large portion of your wealth in a single security, asset, or sector of the market.

While everyone’s financial plan is unique, experts generally recommend having no more than 10% to 20% of your assets in any one investment. That way if one specific stock or asset underperforms, it won’t entirely upend your portfolio.

In addition, you should consider your financial goals and how owning company stock supports your near- and long-term objectives. For example, if you’re raising cash to boost your emergency fund or purchase property, it may not be the right time to buy more stock.

Lastly, beware of tying both your income and investable assets to the performance of your employer. If the company falters for some reason, you may experience a sudden loss of income and a decline in your account balances.

SageMint Wealth Can Help You Develop an Exit Strategy for Your Employee Stock Options

Employee stock options can be a valuable part of your overall compensation package. Unfortunately, most employees with stock options fail to maximize their potential value because they don’t fully understand how.

In fact, a recent survey found that 76% of employees with non-cash compensation have never exercised their stock options. Nearly half of these employees say they’ve held off for fear of making a mistake.

SageMint Wealth can help you navigate the complex world of stock options and develop an exit strategy that’s aligned with your specific needs and goals. We can also help you understand the potential tax implications of your stock options and develop a plan to minimize your tax liability.

To learn more about how we help our clients and see if we may be the right fit for your financial planning needs, please contact us. We’d love to hear from you.

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Anh Tran and Janice Hobbs are registered representatives with, and securities and advisory services offered through LPL Financial, a registered investment advisor. Member FINRA/SIPC.

Anh Tran | Domiciled State: California | 2600 Michelson Drive, Suite 950, Irvine, CA 92612 | CA Insurance Lic. #0F70554.

Janice Hobbs | Domiciled State: California | 2600 Michelson Drive, Suite 950, Irvine, CA 92612 | CA Insurance Lic. #0661646

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