Congratulations, you've been awarded equity compensation as part of your overall pay, bonus, and employee benefits package. This can be a great opportunity to build potential financial wealth.
No matter your level of compensation, it's important to see how all aspects of your financial picture fit together, both short and long term. For example, the proceeds you generate from selling shares of company stock might be used to maximize contributions to your employer-sponsored retirement plan, pay down debt, make a college tuition payment, or simply diversify your investment holdings.
To help ensure that you maximize your stock benefits, avoid making these 6 common mistakes:
Mistake #1: Not taking the time to understand what you have
Equity-based long-term equity incentives come in a number of shapes and sizes, and depending on what you have, you may need to take different action. These awards can represent a significant part of your total compensation—and should be taken into consideration as you build your overall financial plan.
The most common types of awards are:
- Restricted stock
- Performance awards
- Stock options
It's one thing to know what stock and grants you've been awarded, but do you understand how these awards work? Are you familiar with your vesting schedules? Expiration dates? Payout rules? Separation rules? Blackout periods?
There's a lot to learn so take some time to read about how different equity awards work on the Fidelity Stock Plan Resource Center. Talk with your advisor about your specific awards to ensure you haven't missed something important.
Mistake #2: Not knowing the stock plan rules when you leave the company
When you leave your employer, whether it's due to a new job, a layoff, or retirement, it's important not to leave your stock grants behind. Understanding when your awards vest may help you time a resignation. In most cases, vesting stops when you terminate.
For stock options, under most plan rules, you will have no more than 3 months to exercise any vested stock options when you terminate. While you may receive a severance package that lasts 6 months or more, do not confuse the terms of that package with the expiration date on your stock options.
Tip: Corporate mergers and spinoffs can cause changes in your awards. If your company is being acquired, you could see accelerated vestings, new awards in the newly formed company, or even a cash payout of outstanding awards. Contact HR for details on your stock grants before you leave your employer, or if your company merges with another company.
Mistake #3: Neglecting the potential impact of taxes on your awards and the sale of stock
For many people, the ability to maximize their equity compensation benefits can be affected by tax considerations.
In most cases, equity awards will result in ordinary income tax liability when you gain control of shares, and capital gains taxes if you sell shares at a profit.
Tip: It's important to understand when these taxes are triggered, and when tax withholding (if any) applies. Read Equity Compensation: Tax Treatment Guidelines (PDF)
Mistake #4: Not knowing the "in the money" factors affecting option value
A stock option grant provides an opportunity to buy a predetermined number of shares of your company stock at a pre-established price, known as the exercise, grant, or strike price. Typically, there is a vesting period of 3 to 4 years, and you may have up to 10 years in which to exercise your options to buy the stock.
A stock option is considered "in the money" when the underlying stock is trading above the strike price. Say, hypothetically, you have the option to buy 1,000 shares of your employer's stock at $25 a share. If the stock is currently trading at $35 a share, your options would be $10 a share in the money. If you exercised them and immediately sold the shares at $35, you'd enjoy a pretax profit of $10,000.
If, however, the stock price in this example fell to $20 a share, your option would be "underwater." An option is underwater if the current stock price is lower than the strike price. Underwater options don’t have current intrinsic value, and it wouldn't make sense to exercise an underwater option, because you could acquire those shares in the open market at a lower price. However, if the stock price rebounds, the option could return to in the money status, so it is important to be mindful of the details and your company stock price.
Consider these factors when choosing the right time and optimum price to exercise your stock options:
- What are your expectations for the stock price and the stock market in general?
- How much time remains until the stock option expires?
- If you are within 120 days of expiration, it may be time to act, to avoid the risk of letting the options expire. Check with your employer about any black-out periods (when you are not permitted to sell) or other restrictions.
- Will you be in the same tax bracket, or a higher or lower one, when you are ready to exercise your options?
Mistake #5: Concentrating too much of your wealth in company stock
Key question: How much of your portfolio would you be comfortable continuing to hold onto if the stock price of your company stock was to pull back unexpectedly?
Earning compensation in the form of company stock can be highly lucrative, especially when you work for a company whose stock price has been rising for a long time. At the same time, you should consider whether you have too much of your personal wealth tied to a single company's performance.
Why? If your investments are highly concentrated in a single stock, rather than in a diversified portfolio, you may be exposed to excess volatility, based on that one company. Moreover, when that company is also your employer, your financial wellbeing is already highly concentrated in the fortunes of that company in the form of your job, your paycheck, and your benefits, and possibly even your retirement savings.
Tip: Consult with a financial advisor to ensure that your investments are appropriately diversified and read Viewpoints on Fidelity.com: The guide to diversification
Mistake #6: Forgetting to update your beneficiary information
As with your 401(k) plan or any IRAs you own, your beneficiary designation form allows you to determine who will receive your assets when you die—outside of your will. When it comes to beneficiaries, it is important to think about the lifecycle of your awards.
Vested restricted stock and exercised stock options are typically held in your brokerage account and covered by the beneficiary associated with this account. Your unvested awards or unexercised options are a different story. If you have made no beneficiary designation, under most plan rules the executor (or administrator) will, in fact, treat this part of your equity compensation as an asset of your estate.
Tip: Beneficiaries for stock plans are often designated differently from the brokerage account that houses your vested shares. You may need to complete forms with your employer or send a separate set of paperwork to the plan administrator. Review your beneficiaries for your equity awards—as well as your brokerage and retirement accounts—on an annual basis.
Consider working with an advisor to help you create a financial plan that covers a wide variety of investment, personal finance, estate planning, and retirement goals. If you receive stock grants, your plan should also include strategies to help make the most of your total compensation.