Taking Stock
Make Your Employee Stock Benefits Work for You
By: Steven Higgins, Financial Advisor, Principal
Employers offer all types of benefits such as paid parental leave, health insurance, 401(k) plans, etc. …I’ve seen goat yoga Fridays too. Many publicly traded companies also offer different types of benefits that allow employees to benefit from owning shares of the company they work for. These plans can come in all shapes and sizes. This article is not meant to make you an expert; rather help you identify your opportunities and know how to get some help establishing a plan to make your employee stock benefits work for you.
Like all employer benefits, stock purchase plans or awards are meant to attract and retain key talent. The stock benefits are absolutely part of your compensation, but in many cases to participate you have to opt-in. The benefits can be tricky and your decisions can have consequences, especially as it pertains to investment risk and taxes. If you have employee stock benefits, make sure you have someone qualified help you to maximize your plan and keep you out of harm’s way. Here are some of the most common types of employee stock benefits.
Stock Awards and Grants
So, you’re a key asset to the company you work for and as part of your compensation or bonus package you receive stock. There are almost always vesting periods in place in these plans, but this is all very real money and very much yours and should be considered as part of your asset allocation when considering investment risks and objectives. These plans can really pile up for people and lead to over-investment in a single company…and that’s a good problem to have. That being said, we help our clients who are often in higher tax brackets manage a systematic divesture of company stock, taking great care to do so in the most tax conscious way possible. Employees with these plans can also be officers or directors in the companies they work for, and are therefore bound by restrictions to dissuade trading on non-public information (the dreaded insider trading). Appreciated stock awards can make ideal vehicles for charitable giving, as donating the shares can allow a client to receive the full tax benefit of the value of the shares while avoiding capital gains tax. We help clients navigate all of these elements to make these plans work for them.
Employee Stock Options
Like stock awards and grants, employee stock options are a way for companies to reward service and align objectives of the workforce. Often associated with start ups, employee stock options are part of the compensation plan and take many different forms. The basic idea is that the employee is given the right to purchase shares at a specified price over a given period of time when certain criteria is met such as years of service. When the company stock reaches the specified price determined when the option was granted, the option immediately converts to company stock and the employee can sell or hold the shares. Simply put, the employer could grant the option to the employee when a share of company stock is at $1. The exercise price could be $10. When the share of stock reaches $10 and the other criteria are met the employee immediately purchases the $10 share for $1. The option is taxed at the point it is exercised and if the share is sold, the gain is subject to capital gains tax. These can be very lucrative plans if the company is successful. While complicated, it’s important for our clients to know what their opportunities and risks are and how to manage these plans for the most strategic tax outcomes.
Employee Stock Purchase Plan
These plans allow employees to purchase shares of their company on a regular basis through a payroll deduction. One of the key benefits to the plan is that the employee is often able to purchase the shares at a discount. The IRS caps the discount at 15%. For example, if an employee was able to purchase the shares at a 15% discount and the price of the stock stayed stable, the employee would automatically make a profit of 17.6% (15/85=17.6%). The kicker is the employee usually has to hold the shares for a certain period of time before selling, usually one year. It gets better…Some employers apply a “look back,” meaning they look back at the previous quarter and identify the lowest trading price of the stock and then apply the discount (up to 15%) to that price. As financial advisors we get really excited about a plan like that! That being said, there is a risk of taking on too much stock in any company including the one you work for. We help our clients evaluate the risks of owning too much stock in the same company where you earn a living. There is such thing as having too many eggs in one basket and our rule of thumb is that no company should generally make up more than 10-15% of your investable net worth.
401(k) Employee Stock Investment
Most people are familiar with how a 401(k) works but the rules and opportunities about buying shares of your employers stock in your 401(k) are more obscure. Not all companies include company stock as an investment option in the retirement plan, but if they do you may be able to make a pretty savvy and tax favorable move when it’s time to roll your 401(k) into an IRA. Net Unrealized Appreciation (NUA) is the difference between what you paid for the company stock and what it’s currently worth – inside your 401(k). The IRS allows you to transfer the stock in-kind (without selling it) to a brokerage account and pay income tax only on the basis (what you paid for it at the time you acquired it in the plan). The gain would be taxed at the less costly capital gains rate IF you sold it. Those appreciated shares would make ideal assets to donate to the charities you support or contribute to your donor advised fund as you would deduct the entire value of the appreciated shares from your ordinary income and avoid paying tax on the gains altogether. Also, if the owner of the shares were to pass away, the shares would receive a step-up in cost basis at the time of death, making appreciated shares ideal legacy assets.
If you have one of these plans or another benefit through your employer such as a pension, executive deferred compensation plan, or something else, be sure to get guidance before making key decisions as they often are permanent decisions with signficant consequences, both immediate and long-term. As part of our process at Higgins & Schmidt Wealth Strategies, we create plans and processes to understand and maximize employer benefits for our clients. The wealth management process is designed to make all of the elements of a client’s financial wherewithal work together. Employer based plans, which are essentially “optional income,” can be a very important part of that process. If you have questions about your employer based opportunities please feel free to reach out.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful. Rebalancing a portfolio may cause investors to incur tax liabilities and/or transaction costs and does not assure a profit or protect against a loss. Stock investing involves risk including loss of principal. Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price.
