Whether you work for a public company, a large private company, or a startup, as you advance in your career you may be eligible for several benefits meant to reward key employees. These benefit packages are designed to promote retention and to allow employees to share in a company’s success. While executive compensation packages can be lucrative, they come with complex tax rules and financial planning considerations that need to be evaluated at least annually.
One of the most common forms of equity compensation is restricted stock unit (RSU) grants. RSUs are granted to employees as part of a retention and performance strategy. When RSUs are granted, they are unvested, meaning that the employee is not able to sell the shares. RSUs generally vest over a period of years, at which point they can be sold or retained. Employees do not owe any income tax when RSUs are granted, but each vesting event triggers taxable income on the value of the shares on the day they vest. When shares vest, you may elect to sell to cover, meaning to sell some of the shares to cover the income tax owed on vesting. You may choose to keep the remaining shares to participate in the growth of the company, keeping in mind that holding too much of your net worth in your employer’s stock may expose you to additional risk. Your JNBA Advisory Team can help you determine how much employer stock to keep and how much to sell to properly diversify your investment portfolio.
A stock option is a right to buy a certain amount of your employer’s stock on a certain date at a certain price (the strike price). Typically, the strike price is the stock price on the day the option is granted. Like restricted stock, options usually vest over time. If you leave employment before your options vest, you will lose them. If the company’s stock price is higher than the strike price when the option vests, the option is said to be in the money. If you have options that have already vested and are in the money, you can exercise them by purchasing shares at the strike price (and if you choose, selling them at the higher price). It is important to note that when you exercise a stock option, you pay only the strike price, but you will pay income tax on the difference between what you pay and the value of the shares on the day you exercise. For certain options, known as incentive stock options (ISOs), you may not have to pay this tax. The tax treatment of ISOs is complex, so be sure to work with your tax advisor if you are granted this type of option. You do not have to exercise a stock option when it vests, but employer stock options eventually expire, so you will want to make sure you exercise them before expiration if they are valued higher than the strike price or in the money. Deciding when to exercise vested options is an important part of your tax and diversification strategy, and we encourage you to work with your JNBA Advisory Team along with your tax professional to build out a plan for exercising your options.
Some employers offer executives and key employees the opportunity to defer compensation to manage tax liabilities. These plans are known as non-qualified deferred compensation. In this type of plan, you have the option to take some of your regular income and/or bonus and defer it to save on taxes. This compensation is not taxed in the current year and is set aside for payment in some future year, over a period of years, at retirement, or a combination of the above. Your employer will generally offer a choice of investment options for your non-qualified deferred compensation plan that can allow the assets to grow over time. Income tax is owed when the compensation is ultimately paid out. Selecting from the options for payout schedules requires careful tax planning. Your JNBA Advisory Team and tax professional can work together to help you determine the payout schedule that makes the most sense for you to optimize taxes and create an income stream in retirement if appropriate.
Employer Stock in Retirement Plans
Some employers choose to grant employees company stock in their profit-sharing 401(k) plans. In other cases, you may have chosen to purchase company stock with your own 401(k) contributions. If you have accumulated significant employer stock in your retirement accounts, your investment portfolio may not be properly diversified. However, if you are close to retirement and the stock in your 401(k) has appreciated significantly during your working years, you may be able to take advantage of the net unrealized appreciation (NUA) rules to receive certain and potentially more favorable tax benefits. Your JNBA Advisory Team can work with your tax advisor to see if you should consider an NUA distribution from your 401(k) or if you should just sell the company stock within the plan.
When considering the range of executive and key employee benefits available to you, you will need to consider how much of your compensation and net worth to keep in employer stock or deferred compensation plans and how much to diversify as opportunities arise. As you become eligible for these plans or as your employer executive compensation plans change over time, please consult your JNBA Advisory Team to help finalize your benefit elections and diversification decisions.
Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this blog serves as the receipt of, or as a substitute for, personalized investment advice from JNBA Financial Advisors, LLC.
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