With the stock market near all-time highs, more employees see the value of using their stock options to work towards a comfortable retirement. Stock options can be a smart way to rev up your total compensation and help build up your nest egg. They’re a low-cost way for companies to pay their employees more, while also incentivizing them to perform.

But if you want your employee stock options to help you in building a secure retirement, you need to understand your vehicle and the road you’re on. You must let your overall financial needs be the driver and not get distracted by shiny objects along the way. As you navigate your stock option journey, you’ll meet people who can give you the roadside assistance you need to get to your ultimate destination: retirement.

1. Your HR Department Gives You the Keys

Every company’s stock options program is different and you need to understand the ins and outs of yours.

Companies typically issue options at a predetermined price, also known as a strike price. You can purchase the stock at that price any time after the options vest, which at many Fortune 500 companies is three years. You must exercise your options before they expire, usually after 10 years, otherwise they become worthless.

There are two main types of stocks options: Non-qualified stocks options (NQs) and incentive stock options (ISOs). The main difference is the tax treatment. With non-qualified options taxes are usually withheld at the time you exercise your options. You must pay ordinary income tax on the difference between the exercise price and fair market value of the shares.

With ISOs, the exercise date isn’t a taxable event and in some cases you might be able to pay just capital gains tax.

HR’s Roadside Assistance

For specifics on your plan, contact your company’s human resources department for a plan document that spells out all the rules on your specific plan. If you’re working with a financial advisor, you can ask them to join you on a call with the HR staff at your firm. However, advisors are not able to contact your company on your behalf and give instructions about when you want to exercise your stock options—you’ll have to take that step yourself.

2. Your Financial Advisor Draws You a Map

After a long, successful career, you might believe that your firm’s success is your success. While that outlook makes you a valuable, engaged employee, it can sometimes blind you to your own needs for a secure retirement.

A financial advisor can help you see your stock options through the lens of your overall financial needs, not loyalty to your employer. That may mean selling your options even if you feel like your company’s best days are still ahead or you’re aware of an exciting new development in the offing.

By letting your emotions guide you, you might allow your stock options to represent too large a portion of your total wealth. There’s a risk that too much of your financial well being is concentrated in the hands of one entity if both your paycheck and stock options depend on the performance of your company.

What would happen if your company was beset by fraudulent activity or a slew of product failures? You could be laid off at just the time that your stocks options are sinking.

Financial Advisor’s Roadside Assistance

Work with your financial advisor to set price targets for your options so you will have an objective metric by which to measure how well they’re performing. For example, if your company stock is currently trading at $100, set a target for half your options at $110, a quarter at $120 and a quarter at $140. You may not hit the top of the market for all your options, but you can reduce the risk of losing out if your company suffers a reversal of fortune either.

If you’re not able to unload your stock options, consider other strategies to diversify your portfolio. For instance, if you work for a large-cap growth company, you might want to invest in small-cap value stocks to offset that exposure.

3. Your Accountant Steers You Clear of the (Tax) Potholes

Like any journey, there are bound to be bumps along the way to exercising your stock options. Taxes are the main one. A tax professional can help you maneuver around the worst of the tax bite.

Exercising your options could potentially push you into a higher tax bracket or trigger the alternative minimum tax, the exemption for which starts to phase out at $1 million. Seeing clear down the road can let your tax professional identify just the right time to trigger a sale for tax optimization.

By the same token, tax considerations alone shouldn’t drive your decision about when to exercise your options. Just because you’re in a high tax bracket now doesn’t mean that you shouldn’t exercise your stock options if that’s the appropriate thing for your overall investment portfolio.

Accountant’s Roadside Assistance

Salaried employees who receive W-2 forms don’t have much variation in their income. However, if there are times when your income dips, that’s a good time to unload some of your options. If you have an Incentive Stock Option Plan, you might have the opportunity to pay long-term capital gains tax on your options rather than ordinary income tax if you hold your shares for at least a year.

Selling during your working years, though it might result in a higher tax bill, can also be advantageous because you have enough income to pay the tax bill.

By Stephen Kuhn
Director of Investment Research



The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual Stock investing involves risk including loss of principal. LPL Financial does not provide tax advice. Clients should consult with their personal tax advisors regarding the tax consequences of investing. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk. The prices of small cap stocks are generally more volatile than large cap stocks.

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