Congratulations if you are starting to receive stock options from your company! These plans are considered part of a company’s LTIP (Long-Term Incentive Plan). For most employees, these benefits can be realized 1-10 years out. You must stay gainfully employed and in some cases, meet some benchmarks to receive the benefits. We will discuss some of the basics here.
It is important to understand your plan benefits, employers will provide one or all of these, but it depends on the company and its specific goals. Different types of LTIPs are:
- Restricted Stock Units
- Performance Stock Units
- Share Options
- Cash Awards
Many employers will give Restricted Stock Units (RSUs) as a benefit to entry-level executives as an incentive to your overall compensation. Usually, they will give stock units that will fully vest in 3 years. For example, General Motors awards Joe 500 shares of GM on March 2023. This means Joe’s shares will be automatically distributed over a 3-year period. In March 2024 (Year 1), Joe will receive 166 shares, then in 2025, the next 166 shares, and the final 168 shares in 2026. Restricted stocks are provided regardless of performance. There is no specific qualifying criteria.
Performance Stock Units have criteria that must be met to receive them, usually over a 3-year period. Companies have become more creative and specific for the results they desire and these stock units allow companies to truly tie your pay to their desired goals. A basic example is BAE Systems awards 50% of the stocks for their operating cash flow and 50% for their earnings per share. General Motors has a criteria of 40% EBITA, 40% TSR (Total Shareholder Return), and 20% EV. Many startups and smaller companies will put the book value of the company and sales as criteria for an option release.
Share Options are available for you to purchase shares at a predetermined price. This is a stock option is beneficial to you if the stock price rises over time. Usually, the window is 3-10 years. For example, BAE Systems gives Mike an option to purchase 10,000 shares at grant price of $4.98 per share. Between the period of 3 and 10 years from the option, Mike has the option to exercise the option and pay for shares at the grant price $4.98. If at year 5 the stock price reaches $9.00, then Mike can purchase 10,000 shares at $4.98 per share even though they are worth $9.00 at the time.
Options only have value when the share price is above the grant price. Share options are unique in the fact that you are responsible for the predetermined cost of the stock. So, to have no out-of-pocket cost to you, sufficient shares will be sold to cover the option cost and additional shares will be sold to cover the taxes and statutory deductions.
The last type of option is a Cash Award. This is for companies who don’t have a traded stock but still want to get participation from employees.
We will continue with some basics. If you want more information, please look for our other articles or give us a call!
Important factors to consider:
You only pay tax on the stock options when you take receipt of them. These stocks are taxed as ordinary income and included in your W2. If you hold the stocks for a period of time, usually one year after receipt, you can sell the stock and only pay tax on the capital gains of the appreciated stock.
Even though you may have received stocks and paid tax on your W2, you do not have to sell them. Many of our clients are very highly paid executives and the best tax advice is to delay any sales until their income is lower in retirement. This is all determined on the stock price. If the stock price appreciates, then it may be wise to cash out and take the profits!
The timing of the stock sales depends on your company’s outlook. If you feel your company will be worth more in 5 years than it is now, then hold onto the stocks and hopefully you are correct and your stock appreciates. Many stock analysts watch to see if the executives are selling their shares because they believe the stock price is at a high value.
Many companies place restrictions on the upper management that they cannot sell any shares until they meet a minimum shareholder requirement. The executive must hold onto the stock until they have a predetermined amount. Any amount above this is able for sale anytime. For example, you must have 100% of your salary in stock. So, an executive making $300,000 per year must hold at least $300,000 worth of stock before they are eligible to sell.
Material discussed is meant for general/informational purposes only and it is not to be construed as tax, legal, or investment advice. Although the information has been gathered from sources believed to be reliable, please note that individual situations can vary therefore, the information should be relied upon when coordinated with individual professional advice.