For many executives and employees, equity compensation begins as a relatively small piece of a compensation package and gradually becomes a meaningful part of their overall wealth. As the value of those awards grows, so do the decisions that surround it. When should you exercise an option? Should you hold the shares or diversify? Can you reduce the tax impact? What happens when much of your net worth is tied to shares in private company that cannot easily be sold? These questions rarely have one-size-fits-all answers. In this series, we’ll explore some of the strategies available to help investors make more intentional decisions about equity compensation.
The appeal is easy to understand: equity compensation gives employees an opportunity to participate directly in the financial success of the company they helped build. A successful stock option grant, Employee Stock Purchase Plan, or series of Restricted Stock Unit awards can add significantly to an employee’s compensation and, over the course of a career, become a substantial source of wealth. Equity awards can also create useful planning opportunities. Depending on the type of award and the client’s circumstances, there may be flexibility around when to exercise options, when to sell shares, how to coordinate transactions with lower-income years, and how appreciated stock may ultimately fit into charitable, estate, or other long-term planning goals.
Those benefits, however, can introduce risks that are easy to underestimate—particularly once employer stock represents a meaningful percentage of a client’s net worth. An employee whose salary, bonus, future equity awards, and investment portfolio all depend heavily on the same company has multiple sources of financial risk tied to a single outcome. Taxation adds another layer of complexity: different awards are taxed at different stages, withholding may not fully cover the ultimate tax liability, and a poorly timed exercise or sale can create an unexpectedly large income tax bill. Vesting schedules, option expiration dates, restrictions on selling shares, and a natural reluctance to sell stock in a successful employer can further complicate the decision-making process.
There is no single strategy that works for every client or every form of equity compensation. The appropriate approach depends on the type of award, the client’s tax situation, liquidity needs, existing portfolio, time horizon, and broader financial goals. Throughout this series, we’ll take a closer look at strategies such as timing option exercise, funding an exercise through a cashless transaction or loans, and navigating the particularly difficult decisions facing employees of private companies and startups. Each installment will focus on a specific planning decision and the circumstances in which a particular strategy may—or may not—make sense. SFG works with our clients to evaluate these decisions and identify the strategies that best support their unique tax, investment, and long-term financial goals.
Equity Compensation Strategy 1: 83(b) vs. 83(i) Election: Key Differences Explained