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"Experts highlight the significance of company stock, urging caution against overlooking its impact. They offer insights into its potential implications and emphasize key factors for consideration, advocating for informed decision-making regarding investments in company stock."
KEY POINTS
In the race to attract and retain talent, offering equity compensation, which provides employees with ownership stakes in the company, has emerged as a crucial workplace benefit.
A 2023 survey conducted by Morgan Stanley revealed that 72% of companies provide some form of equity compensation to select employees, up from 65% in 2021. This perk serves as a motivator for employees and aligns with their long-term investment objectives, as indicated by the survey, which involved 1,000 U.S. employees and 600 human resource executives.
Despite its advantages, some individuals fail to capitalize on this opportunity due to a lack of understanding, noted Chelsea Ransom-Cooper, a certified financial planner and chief financial planning officer at Zenith Wealth Partners in New York.
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Here’s what to know about three popular types of stock-based compensation, experts say.
A significant portion of employees are awarded what are commonly referred to as stock options as a component of their compensation package. These options grant individuals the privilege to purchase, or "exercise," company shares at a predetermined price within a specified period.
Bruce Brumberg, editor-in-chief and co-founder of myStockOptions.com, a platform specializing in equity compensation, remarked that granting stock options is almost symbolic for startup private companies. Startups aim to foster a sense of ownership culture among employees, offering the potential for substantial wealth transformation.
Stock options gain value when there's a disparity between the preset price and the current market value, increasing their appeal for exercise. However, navigating the tax implications can be intricate and varies based on the type of stock options.
Incentive stock options may provide tax advantages if specific criteria are met, but they might also activate the alternative minimum tax, a secondary tax system applicable to higher-income individuals.
In contrast, nonqualified stock options, which are more prevalent, typically receive less favorable tax treatment, requiring payment of regular income taxes on the discount at the time of exercise.
Moreover, despite the initial discount, there's no assurance that the stock price of a company won't decline post-exercise.
As Chelsea Ransom-Cooper from Zenith Wealth Partners pointed out, it's possible that the option could ultimately be of little value, essentially reducing it to just a piece of paper.
Another advantageous form of equity compensation is restricted stock units (RSUs), which are company shares granted upon employment and gradually become fully owned over time. RSUs can also be contingent upon meeting performance targets.
According to a 2021 survey by the National Association of Stock Plan Professionals, a staggering 94% of public companies extend RSUs to at least middle managers.
Describing RSUs, Matthew Garasic, a Certified Financial Planner based in Pittsburgh and founder of Unrivaled Wealth Management, likened them to a cash bonus.
“I like to think of it like a cash bonus”.
Matthew Garasic FOUNDER OF UNRIVALED WEALTH MANAGEMENT
For instance, if the stock price sits at $10 and 100 shares vest, it's considered as $1,000 in compensation for that year. The usual withholding rate of 22% may prove insufficient, contingent upon your tax bracket, as clarified by him.
For example, if the stock price is $10 and 100 shares vest, it’s treated like $1,000 in compensation for that year, and the standard withholding of 22% might not be enough, depending on your tax bracket, he explained.
Married filing jointly
The table shows the income brackets for married couples filing jointly for the 2024 tax year.
Taxable income, Taxes owed
$0 to $23,200, 10% of the taxable income
$23,201 to $94,300, $2,320, Plus 12% of the amount over $23,200
$94,301 to $201,050, $10,852, Plus 22% of amount over $94,300
$201,051 to $383,900, $34,337, Plus 24% of amount over $201,050
$383,901 to $487,450, $78,221, Plus 32% of amount over $383,900
$487,451 to $731,200, $111,357, Plus 35% of amount over $487,450
$731,201 or more, $196,669.50, Plus 37% of the amount over $731,200
Single individuals
The table shows the income brackets for single individuals for the 2024 tax year.
Taxable income, Taxes owed
$0 to $11,600, 10% of the taxable income
$11,601 to $47,150, $1,160, Plus 12% of amount over $11,600
$47,151 to $100,525, $5,426, Plus 22% of amount over $47,150
$100,526 to $191,950, $17,168.50, Plus 24% of amount over $100,525
$191,951 to $243,725, $39,110.50, Plus 32% of amount over $191,150
$243,726 to $609,350, $55,678.50, Plus 35% of amount over $243,725
$609,351 or more, $183,647.25, Plus 37% of the amount over $609,350
Following vesting, whether to sell or retain RSUs hinges on your short- and long-term investment objectives.
"We typically set a target for how much they prefer to retain in company stock," stated Garasic, who strives to limit allocations of a single stock to 10% or lower. "Once we exceed that threshold, we opt to sell upon vesting."
Numerous publicly traded companies extend discounted company shares through an employee stock purchase plan (ESPP).
Garasic highlighted the potential for "free money" with an ESPP. However, deciding to join usually relies on your short-term financial objectives.
Upon enrollment, your ESPP deducts a portion of after-tax income from each paycheck to purchase discounted company stock on a designated date.
Experts consider a 15% discount with a lookback feature, determining the stock purchase price based on the lower value at the start or end of the offering period, as the optimal standard.
“Any time you’re investing in a single company, there’s certainly a big risk.
Kristin McKenna PRESIDENT OF DARROW WEALTH MANAGEMENT
Although you can usually sell after a specified period, there's no assurance of profitability, even with the included discount.
"As with any investment in a single company, there's undoubtedly significant risk," emphasized CFP Kristin McKenna, who serves as president of Darrow Wealth Management in Boston, in previous remarks to CNBC.
McKenna suggested prioritizing annual objectives such as investing up to your employer's 401(k) match before considering your ESPP, particularly when facing limited income.
Source: cnbc
