Simplifying the Equity Compensation Complexities: Keep it, Spend it, or Save it

If you’re wondering how to maximize the value of your incentive stock options (ISOs), non-qualified stock options (NQSOs), restricted stock units (RSUs), or other forms of equity compensation, you’re not alone. After all, there is plenty to think about if you’ve been granted equity compensation. You may dream of how to strike it rich. You may fear you’ll do something wrong and miss out. You might become mired in taxing technicalities, including AMT calculations.

All that thinking can backfire if “TMI” (too much information) prevents you from proceeding.

Can’t decide how to decide what to do with your equity compensation? That’s an unintentional decision in itself.

Simplifying the Equity Compensation Complexities: Keep, Spend, or Save it

Fortunately, we believe anyone can make sensible decisions about their equity compensation. Just start by remembering, there are really only three “buckets” for allocating your equity compensation. You can:

1. Keep the stock or stock options
2. Spend the stock proceeds after selling it
3. Save (Invest) the stock proceeds after selling it

How much of your equity compensation stock do you want to keep, how much do you want to spend, and how much do you want to save (or invest)?

By leading with this crucial question, you can more easily eliminate the complexities that lead to paralysis. Instead, lean into the key decision that seems most relevant for you.

Deciding to Decide May Be the Hardest Part

It takes a deliberate act to convert stock or stock options to cash. So, if you don’t do anything, you’re effectively deciding to keep everything in your “keep” bucket. As such, hanging onto your equity compensation may be less of a decision than an accident, based on interference from personal and behavioral inner dialogues that might sound like one or more of these:

• Above all else, I want to pay less tax by waiting for long-term capital gains (particularly with ISOs)
• I know and believe in the company I work for. It feels wrong to “sell out.”
• I’m waiting for the stock price to go back up.
• I’ll sell once the stock price reaches “X” dollars.
• I’m afraid I’ll make a mistake.
• What if I miss out on the upside?

Unfortunately, resolving these quandaries is not always easy. Your thoughts and emotions are valid, we can’t know what the future holds, and hindsight regret is a powerful, potentially debilitating force.

While you’ll want to acknowledge your inner debates, one way to cut through to the real financial reason to keep some or all of the stock may be best reached by asking yourself:

Is this the highest, practical use for the money?

In that context, let’s explore how to allocate your three buckets of opportunity.

Bucket #1: Keep the Stock or Stock Options

The Thought Process: There is no singular answer to how much company equity you should keep. So, where do you start? First, consider the risk of holding a single stock position. In that context, how many shares/options should you keep? The more equity you hold, the more money you can make if the share price goes up … but the more you might lose if the price goes down.

With this in mind, you can begin to consider how much of your net worth is tied up in equity compensation. One rule of thumb suggests a suitable allocation to a single stock position is 10-15% of your net worth. While this may not be the right solution for everyone, it’s a benchmark you can use in your planning.

Another way to evaluate equity is to establish a balance between your wants and needs, where even a total loss would be unfortunate, but never a disaster for you and your family:

• • Wants: If the current value of your stock or stock options could be spent on wants, you’re better positioned to hold more shares for longer, hoping to expand on your current lifestyle.
  • Needs: If you need the stock’s current value to fund your current lifestyle or eventual retirement, think carefully about whether you can afford to continue putting that present value at risk.

Whatever your metric, or whatever your plan calls for, evaluating how much equity you want to keep is one step in the plan.

An Action Plan: While you’d think keeping your stock and stock options means no actions are necessary, you’d be prudent to dig deeper to take advantage of related planning opportunities.

For the equity you decide to keep (if any), you can usually either retain your options without exercising them, or exercise and hold, converting your employee stock options into stock shares. This either/or choice applies to ISOs or NQSOs. With RSUs, you typically take ownership of shares of stock once they vest and are no longer subject to a substantial risk of forfeiture.

Generally speaking, you may be better off leaving NQSOs unexercised, while you pursue their potential growth. Once you exercise them, you’ll incur ordinary income taxes whether you hold or sell, so it’s often logical to sell them at the same time.

You can also retain unexercised ISOs. However, if you are seeking a qualified sale in pursuit of more favorable tax treatment, and you are willing to evaluate AMT and AMT credit (if applicable), an exercise and hold of some or all your ISOs may be your best bet.

Timing Tips: For the stock you keep in pursuit of higher returns, how do you know when it’s time to say “when”? First, you’ll want to be aware of any sale restrictions that apply to you, such as lock-up or blackout periods when you cannot sell. One way around this, particularly for executives, may be to establish a 10b5-1 plan.

Beyond that, it’s important to have a plan in place with regards to your “kept” equity. Because most people will likely want to sell at some point, we suggest targeting a future dollar value or price at which you’ll have reached your personal financial balance, as described above. By having this sort of plan to go back to, you may be less tempted to get caught up in the excitement and take on more risk than you should.

Bucket #2: Sell and Spend

The Thought Process: As important as it is to invest for the future, enjoying your money today matters too. That usually means spending some of the fruits of your labor sooner than later. As we described in this ISO tax article, you can think of your equity compensation as another form of taxable payment for services rendered, or better yet, a bonus.

If you’re financially stable and come into extra cash, it’s often justifiable to want to spent some of it, even if it means incurring ordinary income taxes when you sell—rather than squirreling away every bit of it for a distant date.

You probably have many spending goals. Some might be typical financial planning goals like:

• I want to buy a house (or a vacation home)
• I want to pay for college
• I want to pay down debt
• I want to gift to the kids
• I want to contribute to a Donor Advised Fund

Other times, it can be bucket list adventures or personal luxuries, such as:

• I want to take a trip around the world
• I want to buy the car I’ve always dreamed of

An Action Plan: Again, being in a sound financial position is an important first step. It helps you spend freely and joyfully on that which you can afford, without worrying about overspending on that which you cannot.

Determine how much you’ll sell, and what it can buy for you, such as a new home, a new boat, the trip of a lifetime, a spa day, or whatever else is at the top of your wish list within the budget you’ve gifted yourself. Above that, you should also carve out the amount you’ll need to cover any taxes due on the sale. For example, if you’ve budgeted to spend $100,000, you may need to sell $150,000 worth of stock: $100,000 for spending + $50,000 for the taxes.

In deciding how much you’ll sell and spend, do remember the obvious: Once money is spent, it’s gone and may no longer be part of your financial plan.

Timing Tips: Different shares may be subject to different tax rates, such as long-term or short-term capital gain, or ordinary income rates. Consider working with a financial professional to select which shares to sell in what order, based on details such as how long you’ve held them, and (for ISOs) whether it’s a qualified or disqualified sale. Again, even if you end up incurring a higher rate by not waiting to sell, think of it as the taxes due on an extension of your salary. It’s great to minimize taxes when you’re able, but it isn’t necessarily your only mission in life.

Bucket #3: Sell and Invest

The Thought Process: Again, at some point, it often makes good sense to sell some of your company equity (which exposes you to single-holding risk) and direct the proceeds into a diversified portfolio. Remember, neither gains nor losses are really yours until you actually sell the stock, so your core motivations are relatively simple: You want to mitigate the concentration risk, protect your assets, and establish financial freedom.

You may be in a position to sell and save or invest, if you think the following:

• My equity is worth more than I ever imagined, and I can have financial freedom. (Why put that freedom at risk, if something were to happen to your company?)
• I shouldn’t be overconcentrated in a single company stock relative to my net worth.
• I believe investing in the broad market will offer similar or better returns with less risk.
• I am approaching retirement and want to diversify or preserve what I’ve got.
• I am leaving/have left the company.

Beyond feeling you want to sell some of your company stock and invest it elsewhere, there may be other reasons to sell. For example, you may:

• Be subject to a pre-determined plan or 10b5-1 plan that obligates you to sell some shares.
• You may have options that are set to expire, and if you do not act, the value is lost.
• Own RSUs that have vested, have ISOs that have become eligible for a qualified sale, or acquire employee stock purchase plan (ESPP) shares you’d rather not continue to hold, or that have reached “tax efficiency.”

An Action Plan: When you invest rather than spend money, the goal is to generate more wealth over time, or at least preserve the spending power of what you already have. For this, you’ll may want to build or add to a low-cost, globally diversified investment portfolio, allocated across a mix of stock and bond asset classes that reflect your personal financial goals and risk tolerance. Also, if you invest the proceeds in a taxable account (versus an IRA or similar tax-sheltered account), be mindful of investing in tax-efficient vehicles.

Timing Tips: Whether you’re selling company stock to spend or invest, the same share-selection caveats apply. And once again, before you invest the proceeds, make sure you’ve set aside enough to cover the tax bill.

Beyond that, we’re often asked if it’s better to reinvest everything at once, or over time. We understand why some may hesitate to jump in with both feet. But for the entire portion you plan to invest long-term, we believe sooner is better. Think of it as shifting assets already invested in a single stock into a more diversified portfolio. Since markets are expected to grow over time, while cash is expected to lose to inflation, there’s no expected advantage to waiting to reinvest.

The Recap: Keep, Spend, or Save?

By now, we hope you’re getting the hang of how to think through what to do with your equity compensation. There are a lot of details to handle as you proceed. There’s also the alure of vast potential wealth—trees growing to the sky—running up against practical financial planning.

To avoid becoming gridlocked by indecision, try leading with our three-bucket strategy:

How much stock will you keep? How much will you sell and spend?

How much will you sell and save (invest)?

Once you’ve got your buckets in place, you can more accurately develop action plans that align with your goals. Your plans can then drive your tactics. After that, it should be a little easier to implement, monitor, and update your equity compensation plans over time.

Managing your equity compensation may never be a walk in the park, but at least you’ve now got some good marching orders to see your way through. Still undecided? Give us a call and we can continue the conversation.

This material is intended for informational/educational purposes only and should not be construed as investment, tax, or legal advice, a solicitation, or a recommendation to buy or sell any security or investment product. The information contained herein is taken from sources believed to be reliable, however accuracy or completeness cannot be guaranteed. Please contact your financial, tax, and legal professionals for more information specific to your situation.