Taking Stock: What You Need to Know About Employee Stock Options, Restricted Stock Units, and Deferred Compensation

Louis Butera |

In many corporations, company stock is a part of the total compensation package offered to employees, especially key managers, contributors, and executives. But there are different types of stock shares and stock purchase plans, and they can have a big impact on your overall income, taxation, and long-term financial picture. Even if you just own some shares through the company’s 401K plan, or a non-qualified stock purchase plan (open to all employees), be certain you understand the short- and long-term implications.

Incentive Stock Plans

From a corporation’s perspective, giving employees stock is a logical way to align personal objectives with the company objectives, and to reward longevity and performance. And if the company is profitable it can be a lucrative benefit for employees.

Incentive Stock Option (ISO) plans are one way to do this (also referred to as Qualified Stock plans). Typically these plans offer the option for an employee to purchase shares of stock for a set price after a certain date, with a vesting schedule. If the option price is lower than current market price at the time you exercise your option to buy, then you see an immediate increase in the value of your investment.

For example, let’s say your option price is $20 per share, good for a period of 10 years. In 10 years the stock price is at $40/share, so if you exercise your option, you will have gained $20/share (if you sell your shares at that time to reap the profit). Or if you hold on to your shares and if the stock later goes to $60/share, you will have gained a profit of $40/share.

ISO plans typically offer more favorable taxation than other employee stock purchase plans, but the taxation rules can be complex, so be sure to consult with a financial advisor before exercising options or selling ISO stocks. Learn more about stock option plans.

To make the best choices with your stock options means looking not only at the value but also the timing of any actions you take. The advisors at Butera Wealth Management (BMW) can help you devise a strategy to get the most value for your options and minimize the tax impact. We can also make sure stock options and other aspects of your employee compensation package are well balanced with your entire financial picture.

For example, there are some cautions about stock option plans. You don’t want to end up with “all your eggs in one basket”, i.e., having your income, investment, pension, and retirement savings all depending on the future performance of a single company, which can increase your risk. Learn more about stock option risks.

Restricted Stock Units

Another type of employee stock plan offers Restricted Stock Units (RSUs). Instead of options to purchase stock, these are grants of actual shares, typically on a vesting schedule, often at three years. Whatever the market share price of the stock at that time determines the total value of the stock you receive. Some companies grant RSU in separate chunks for each of three years. A financial advisor can help you figure out how these grants will affect your tax liability and your overall investment and income planning. Learn more about Restricted Stock Units.

Deferred Compensation

Another element of some management and executive compensation plans is deferred compensation. The idea it that you can “postpone” receiving some of your income for a point in the future such as after you retire. This can help lower your tax liability during peak earning years and spread out your income to ensure greater continuity. For example, receiving deferred compensation can enable you to postpone taking Social Security income until you reach the age of maximum benefit.

However, decisions you make to defer compensation are irreversible. You need to be sure you’ve carefully considered the long-term impact. You may want to line up other distributions to buffer the delay in receiving this compensation. Learn more about deferred compensation.

Looking at the Big Picture

Whether your compensation package includes 401K, stock options, or other elements, it’s important to look at the whole, integrated picture of your financial income and assets. You want to consider current and future tax liabilities, the costs, and the opportunity costs of exercising options or selling shares at different times, stay ahead of any deadlines. Think about how you might want to use the additional funds—pay off a mortgage? Finance your child’s college? BWM can help you run different scenarios, understand your options, and make the choices that appropriate for you.