In this week's episode, we're going to start diving into using equity compensation to pay for college. It should be rather straightforward, right? Just sell some equity compensation, pay the applicable taxes, and then use whatever's left to pay tuition. I guess that is kind of simple, isn't it? Of course, doing it both effectively and efficiently is another story. Things such as optimizing any financial aid from the college you may qualify for, not messing up your future retirement plans, and as always not tipping Uncle Sam by paying out more in taxes than necessary. Listen up as we get down to the details!
You will want to hear this episode if you are interested in...
Selling equity compensation positions and using proceeds to pay for college [1:23]
Recap on NSO’s [3:06]
Using restricted stock unit’s [6:24]
Employee stock purchase plans [7:57]
Why you should sell the positions with the smallest gains [10:16]
This week’s FLASHBACK [12:43]
Things to remember when selling NSO’s and RSU’s to fund tuition
When you're awarded non-qualified stock options from your employer there's nothing you have to report regarding income. Additionally, there's nothing to report when it becomes exercisable either. That's one of the beauties of non-qualified stock options. You can just receive them, let them grow without tax liability, and only worry about the tax liability when you actually exercise the options.
With RSU’s once you meet the vesting requirements— which are often connected with staying employed for a certain period of time— you have to recognize those RSUs as compensation income. This is step one. The more important step when paying the college bill is how the sale will be treated for tax purposes? Fortunately, it's just like the disposition of any other stock you own. It falls under capital gains rules. If you hold it for a longer period of time the proceeds are traded with a lower long-term capital gains rate.
Be smart when choosing positions to sell to pay for college
Selling the equity compensation positions with the smallest gains will keep more money in your pocket. For example, you have 2 RSU’s, one has a basis of $50 and the other with a basis of $200. The company stock is now trading at $500. Remember you're paying capital gains rates on the difference between your cost basis and the sale price. In this assumption, you need to sell $50,000 worth of shares to pay the upcoming tuition bill. For both cases, you need to sell 100 shares at $500.
However, if you sell 100 shares of the positions with a cost basis of $50 a share your total cost basis will be $5,000, 100 shares x $50. The difference between the $5,000 cost basis and the $50,000 total proceeds from the sales is a $45,000 long-term capital gain. With the other cost basis of $200 your cost basis for those 100 shares is $20,000. That makes your long-term capital gain $30,000. Capital gains will apply to this $30,000 bill which is much smaller than the $45,000 if you used the lower cost basis shares.
This week’s FLASHBACK: The good old paper route
My first job ever was a paper route that I shared with my older brother. It was too big for one kid— at least from my 12y/o perspective— so we did it together until he went to high school and I got a smaller route I could handle on my own. I walked the route because admittedly, I wasn’t coordinated enough to carry the bag and ride a bike at the same time. But, I can still fold a paper and toss it onto a front porch so it pops open just right. I may be the only person that’s proud of that but at least I didn’t need rubber bands.
Back then you didn’t just deliver the paper you also collected payments. I hated that part. You never knew if customers would be home and when they weren’t. If you missed them you would have to keep going back to get paid. It did help me to learn how to get people to pay bills which is an important skill now that I am a business owner.
I’m Dan Johnson, CFP®, founder of Forward Thinking Wealth Management. I run a flat-fee financial planning and investment management firm located in beautiful Akron, OH. Although I am in Akron, OH, I work with clients regardless of location. I cater to owners of equity compensation positions who are looking to organize their financial lives, keep more of what they make, and do the things they want in retirement and even now.