Effectively navigating equity- and option-heavy wealth
Renee Newman
Wells Fargo
Could you imagine receiving $50,000 from your employer, then turning around and throwing it in the garbage? Surprisingly, many people who receive stock options as part of their compensation do just that when they don’t plan on how they’ll manage these options, even with amounts more than $50,000.
Could you imagine receiving $50,000 from your employer, then turning around and throwing it in the garbage? Surprisingly, many people who receive stock options as part of their compensation do just that when they don’t plan on how they’ll manage these options, even with amounts more than $50,000.
Stock options and equity compensation are still widely used. Yet wealth on paper does not necessarily translate into real world returns – particularly if it’s not managed or planned for appropriately.
Creating the right approach
Options do not always expire at the most opportune time. Blackout periods and your timetable to cash out when you leave a company are just two factors to consider when putting a strategy in place to avoid leaving money on the table.
One survey found about 11 percent of the respondents had allowed vested, in-the-money options to expire unexercised. Some of this loss was due to poor timing. In other instances, people had forgotten what they had and when they needed to take action.
Tied to the company ship
Many executives might fear exercising options could have political ramifications or cause others to think they are retiring or lost faith in their company.
In most cases, exercising options is used to rebalance a portfolio and says little about an individual’s next career move. When your salary, options and 401(k) investments are all tied to a single company, there can be a great deal of risk.
Diversification is the key to capturing the wealth offered in stock options and avoiding a poorly balanced portfolio.
A good rule of thumb is to have no more than 10 percent of an investment portfolio concentrated in a single company. Unfortunately, many investors do not apply this rule when it comes to their employer’s stock.
The cumulative effect of stock option and restricted stock grants, Stock Appreciation Rights, Employee Stock Purchase Plan purchases, and purchases of company stock in qualified retirement plan often results in concentrations over the 10 percent threshold.
Charting the best course
When it comes to exercising options, the how often is just as important as when. Many individuals get in trouble by using margin – or borrowing money from their broker – to exercise. This is a risky approach.
The most obvious risk is that a stock price might drop and the investor finds him or herself with shares under water and facing a margin call, or restitution on the loan.
The second risk relates to the poorly understood Alternative Minimum Tax (AMT). Exercising an option does not create an income tax event using standard tax accounting methods.
Yet under the AMT, the difference between the market price and the option price is considered taxable income. Individuals whose AMT results in a higher tax than the traditional method must pay the AMT.
Having a plan is essential. Here are five factors to consider:
• Determine what role your stock options, company stock and Stock Appreciation Rights play with regard to your short-term cash flow needs and overall financial goals.
• Determine how much concentration you want in your company stock and how much of a reduction you need to meet this goal.
• Decide whether to sell stock held in retirement plans, sell stock outright, or exercise stock options to meet their accumulation, cash flow and diversification goals.
• If you decide to exercise options, determine if there is a significant tax difference between exercising a large amount in a single year or exercising the options over several years.
Consider the method for exercising, how that can affect what you might owe the government, and whether estimated taxes will need to be paid.
Renee Newman is a private banking manager with Wells Fargo Private Client Services in Vancouver. She can be reached at 360-993-3752 or newmanrl@wellsfargo.com.
