Planning on leaving your job? How to plan for your employer stock options.
Whether you just got fired, are leaving your employer to pursue another opportunity, or retiring, you need to make sure you understand what happens with your stock options as this could have a huge impact on your tax situation and your retirement plans. This is a complicated topic with a lot of “it depends” so the best advice I can provide is to check with your plan documents and discuss with your financial and tax advisor. However, that’s not the answer you came here looking for so I’ll provide things to consider that you might be able to apply to your situation. My hope is this will help you get a better understanding of your options and help you decide the best course of action.
Stock Option Expiration and Employment Termination
All stock options have an expiration date, which is the last day you can exercise your option. Most stock options have a 10-year expiration starting from the grant date. This means you can exercise your options to purchase the shares of the company (and then sell those shares) at any point between the vest date and the expiration date. However, if you leave your employer your timeline for exercising your options may be shortened, sometimes dramatically. Your new expiration date will be set forth in the plan documents and depend on why you left employment, e.g., retirement, terminated, death, disability, etc. This could be as short as 30 to 90 days which can have a dramatic impact on your ability to control your taxes since non-qualified stock options or NQSOs are taxed when you exercise them. After you exercise, capital gains tax rates apply to the realized gain or loss on the sale of the shares, which is usually minimal if you sell immediately upon exercising.
Stock Option Vesting after you Leave your Employer
Before leaving your company (if you control it) you need to take a close look at the vesting schedule for all of your stock options. This is because, in most cases, you will lose all your unvested stock options, even if they are in the money. I.e, they may show value on your account statement but if they are unvested at the time you leave your company you will never receive that value. Therefore, if you are planning your departure you should consider which month to do so as you could have a portion of a stock option grant vesting within a short period of time. Even if you dislike your job you may want to stick around a few more months (or longer) to capture this value. This is where the term “golden handcuffs” comes from - it can sometimes become a very expensive proposition to leave your employer. Alternatively, if you are going to a new employer you can use the value of the unvested options as a bargaining chip. If your new employer wants you to work for them bad enough, they may offer you a signing bonus or their own stock options to make it happen.
Let’s take a look at an example to see what this might look like:
If this employee left their job today, they would be missing out on $368,875 of value ($443,895 Total Value less $75,020 vested value). If these remaining options vest over the next year, you have a big incentive to remain employed with your current company. However, if you can use this information to negotiate a $250,000 signing bonus, you might still make the move to pursue a better career opportunity.
If this employee were retiring, the decision is similar but with different incentives. Depending on your health, current investments, and retirement goals, the extra year of retirement might be well worth the forfeited value. Based on a “safe-withdrawal rate” the remaining $368k of value could allow you to spend almost $15,000 more per year in retirement. That is not an insignificant amount of money but again it depends on your plan and goals. The point is to make sure you understand the impact and timing of your decision to retire and leave your employer.
From a tax perspective, this reduced timeline also shrinks your tax planning opportunities. While you are with your employer you have many opportunities to reduce your taxes. For example, you could:
Exercise small amounts each year to spread the income
Exercise more in years with lower income
Exercise less in years with more income (bonus, other compensation)
Manage the risk of specific stock exposure
If you leave your employer and you have to exercise a large amount of your stock options in one year you could push yourself into a higher marginal tax bracket and pay more taxes than you otherwise would ever have to pay. Because of this, if you are near the end of the tax year you may want to delay your retirement or separation date to at least spread your stock option income over two tax years. For example, if you were thinking of leaving your job in December, instead, exercise some of your stock options in December, and wait to leave in January of the next year, and exercise the remaining options at that time. This strategy depends on a lot of factors but it’s worth considering.
I died, what happens to my stock options now?
If you get to this point you probably aren’t thinking of your stock options, but your beneficiaries certainly are. Generally, you are afforded a longer timeline if you leave employment due to death or a disability. In these cases, you could get a year to exercise your options. Again, it’s best to check your plan documents for the exact rules.
This extended timeline provides some additional time for your options to vest as well as some additional planning opportunities. If you are given 12 months to exercise you are crossing over two tax years. By spreading your income over two years, instead of one, you are less likely to push yourself into a higher marginal tax bracket when you exercise.
In the case of Incentive Stock Options (ISOs) you could have the 3-month exercise requirement waived upon death and still retain the ISO status of the option. Again, check your plan documents.
Obviously if you die, it’s your beneficiaries or personal representatives who will be handling the exercise and sale of your employee stock options, so make sure your beneficiary designations and estate planning documents are in place.
Knowledge is Power and Power is Good
There are many reasons to leave your employer, not all of them financial. However, knowing where you stand with your employee stock options may help you make a better decision around pursuing another career opportunity or retirement. Know how much value (after-tax) you are leaving on the table. Know that you will likely have a shortened timeline to exercise. Know your options and you will, no doubt, make the best decision for your future prosperity and happiness.
If you have questions about your employee, non-qualified, or incentive stock options schedule a phone call to discuss with a Phillip James advisor.
All the information contained herein is for illustrative purposes and should not be relied upon for tax, investment, or legal advice. You should consult with your fee-only financial advisor to decide what is best for you based on your specific situation. It also helps if your advisor is also a tax preparer.