You just met with your HR team, who shared with you the good news: You’re eligible to own employee stock in your company! An incredible benefit, especially since you feel that you can impact how well your company stock performs, either directly or indirectly.
But you walk out of the meeting, head spinning with choices and acronyms – ESPP, RSU, stock options and/or 10b5-1. What does all this mean? How can you make the most of this amazing employee benefit?
Let’s go through each of these stock plans individually so you know exactly what your benefit is.
Employee Stock Purchase Plans (ESPP)
Employee Stock Purchase Plans (ESPP), or incentive stock options, allow you to make salary deferrals each pay period to build up a pool of money with which you can purchase your company’s employee stock option at the end of the plan period. The plan period is often six months. The plan could allow you to purchase stock at a discount to the market price. This promotes employee ownership of their position. What a deal!
Before you sign on the dotted line, keep in mind that your contributions might be post-tax and won’t be considered qualified assets. This means an ESPP is different than your typical traditional 401(k), which is funded with pre-tax dollars and taxed at withdrawal (if after the age of 59 ½). Knowing this detail of your ESPP plan is critical to keeping within your budget for that year and planning for that year’s tax filing. Ask your plan administrator regarding the specifics of your plan.
Restricted Stock Units (RSU)
Restricted Stock Units (RSU) are generally granted in a block of shares with a vesting schedule. It’s best to use an example to explain RSUs.
Your company grants you 500 shares of stock on April 1, 2020, that has a 4-year equal vesting schedule. This means that every year on April 1, you will have 125 shares vest – you own them outright. Generally, RSUs are granted with a $0 cost basis so you didn’t have to pay anything to receive them; your “payment” is your continued employment with the company.
In many plans, taxes are also due upon vest. Some companies will allow you to sell enough shares to cover the cost of the taxes due, and some will allow you to pay the taxes outside of receipt of those shares – be sure to verify what your employee compensation plan and company allow. This type of grant is generally considered non-qualified stock options.
Stock Option Grants
Stock option grants allow you to purchase shares of stock for a certain amount of time after vesting at a reduced grant price. I’ll use an example to explain this grant, too.
On April 1, 2020, your company issues stock options at the closing price of your stock that day: $15.75. You receive your grant package with 500 shares and a 4-year equal vesting schedule. Stock option plans will generally allow you a certain amount of time after all shares vest for you to take advantage of stock appreciation.
Let’s say you have six years after the date of final vest to exercise your options. For this example, you will have until March 31, 2030, to exercise your options and purchase 500 shares of your company stock at $15.75 – no matter what the price of your company stock is in the open market. If your company is trading at $60 a share, that’s an immediate gain of $44.25 a share! That’s $22,125!
Now, don’t rush out to put a down payment on that sports car you have always wanted just yet. Yes, you saw a $22,000+ gain – but that’s taxable income in the year you exercise. This could significantly impact your income tax filing for that year. You will want to be in contact with your tax professional before exercising any stock options to ensure you’re prepared for any potential tax impact.
10b5-1 Stock Option Plans
Finally, 10b5-1 plans. No, I didn’t just shout out a Bingo number incorrectly. These plans are named after the SEC rule that allows for this type of trading of employer stock. Generally, 10b5-1 plans are executed for your executive team, finance team or other departments that are impacted by blackout trading periods. These plans are executed during an open trading window, and they set specific trading instructions for disposal of company stock. This allows for reducing possible employer stock concentration even while you may be subject to a blackout trading restriction.
Understanding Your Employee Stock Options and How They Fit Into Your Financial Plan
There are many benefits to receiving grants of company stock. The trick is understanding exactly what the grants mean for your situation. Are the grants considered non-qualified? How will the grants impact my taxes and when would taxes need to be paid? When do I need to take action on the grant? What happens to the grants if I don’t take action in the right amount of time? What happens if I leave the company? What happens to these grants if the company is purchased or merges with another company? What happens if the stock price goes down while I’m waiting for my grants to vest? What is the fair market value of your stock?
Your employee stock purchase plan documents should address these questions, but a financial advisor who understands your overall financial story can better explain and help you manage your choices. The best thing you can do for yourself is to take advantage of this benefit in a way that won’t negatively impact your current or future financial health. A financial advisor can help review your grant documents, employee stock ownership plan, capital gains tax, and even your ordinary income tax and then develop a financial plan to determine the best course of action when it comes time to receiving shares from your grant.
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