Author: Ben Hardigg, CFP®, Vice President, Wealth Advisor
Many corporate compensation philosophies believe providing employees long-term incentive and stock options are a key tool for recruitment and retention. For the employee, this benefit is an important part of creating long-term wealth and planning your stock market strategy can have a tremendous impact on your net worth.
There are several considerations when implanting a stock option strategy. Consider the type of stock option, your personal tax implications, life cycle and company valuation, and concentration of net worth. Furthermore, there are a variety of strategies to maximize rewards based on personal goals.
The two most common types of stock options are incentive stock options (ISO) and non-qualified stock options (NSO). The main differentiators are structure and taxation. ISOs offer employees the opportunity to buy stock at a discounted price and are typically taxed at favorable capital gains rates if holding periods are met and stock is sold. NSOs function in a similar manner, except the employee is taxed on the spread between the grant and exercise price at ordinary income tax rates. No matter which type of stock option is held, you will need to plan for the inevitable tax consequences. Because NSOs have a limited window (typically 10 years), planning needs to happen to focus on the future tax impact.
Understanding the valuation and outlook of your company stock price is critical to ensuring maximum value. There is the intrinsic value, which is the value between current and grant stock price. More importantly, there is the "time value", which can be broken down to paying the exercise price at some point in the future (providing an interest-free loan) and loss of current intrinsic value, but no further losses beyond the grant price (if you hold shares of stocks outright, the value can continue to lower to zero). This inherent power of leverage in stock options allows for a floor with unlimited upside potential. Even thought you may not have immediate intrinsic value, thanks to the length of time to expiration, these options have a significant amount of time value that should be discounted through early exercise.
As we have seen in the past 12 months, a downturn in the economy can decimate portfolio value, especially when holding concentrated positions. You should always ask, "what does your situation look like if your company stock drops by 10, 25, or even 50%?" Professional money managers typically do not let a single position account for more than 5% of a portfolio and repeated awards of stock options can quickly make this a significant portion of investments.
Understanding your awards and utilizing strategies based on your personal situation is key to maximizing personal wealth as you are navigating your career. Our goal is to help clients make the best decisions given options available to help achieve goals set forth.
If you have questions about stock option strategy, reach out to your HORAN wealth advisor to discuss the best options for managing your portfolio.
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