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Stock Options - The Basics, Episode 10

Equity compensation is a tremendous way to grow your wealth directly through your company's success. However, it can get complicated quickly. My hope is that clients will take the time to understand and make sense of their equity compensation so that they are able to do the things they want in retirement. Today we will be talking about the ins and outs of stock options. Join me to learn more and how to get the most out of this time-sensitive alternative compensation option from your employer. 


You will want to hear this episode if you are interested in...

  • A couple of truths about equity compensation [0:26]

  • What is a stock option? [1:38]

  • Common time restrictions to be aware of [2:17]

  • Cliff vesting [2:35]

  • Graded vesting [3:02]

  • Overall timeframe to exercise your options [3:25]

  • What does it mean to be “in the money” and is it as good as it sounds? [4:03]

  • Options for paying for your options [5:50]

  • When is a stock option a risk? [6:36]

  • Incentive vs Non-qualified stock options [8:03]

  • Incentive stock options (ISOs) [9:23]

  • The sales tip section: Choose “hell yes” clients [11:48]

  • This week’s FLASHBACK: School photos [11:23] 

What it means to be in the money

Let's walk through an example… you have 4,000 shares of stock options awarded to you and your employer has graded investing of 25% a year. These shares have been awarded when the stock price is at $20. Every year you get the option for 1,000 shares and after four years all 4,000 shares are fully vested. Now the stock price has increased to $35 a share. This is called “in the money”  because the price has gone up in value from your initial price. You can exercise these options and buy the 4,000 shares at $20 each even though they are worth $35 a share. You pay $80,000 or shares that are worth $140,000 on the open market. Not too bad of a deal, right? Be mindful of your specific rules and deadlines on exercising options. Statistics show that 11% of people miss out on “in the money” options because they didn’t pay attention to the time restrictions. Check out the episode to learn more on stock options!

Tax expectations with non-qualified options

The two types of stock options are non-qualified and incentive stock options. Non-qualified are most common, I heard recently that 95% of all options are non-qualified. Non-qualified means they do not meet any rules to qualify for special tax treatment and this is what I see with my clients that work for publicly traded corporations. When you exercise non-qualified options you have to deal with taxes. 

Compensation income is the difference between your exercise price and the actual stock price. When you exercise, as in our example above, there is a $15 difference between the $20 you paid and the $35 the stocks were worth. The IRS treats this as ordinary income and you’ll have to pay taxes on it, including income, social security, and Medicare tax. When you sell the shares, proceeds above or below that $35 price will be taxed at capital gains and losses rates. Listen to the episode to learn more about the less common incentive stock options. 

This week's sales tip: Choose “hell yes” clients

I live in a relational world. I don't do transactions like “financial advisors” that sell insurance policies or slam customers into annuities. I'm a certified financial planner (CFP) and my goal is to have a long-term relationship with my clients. Because of that, I have to be careful about who I take on. At the end of every conversation that I have with a potential client— and even an existing client— I asked myself “is working with this person a HELL YES?” If not it's probably best for us to part ways. Life is too short and stressful for either of us to be working with someone who isn’t fully committed to the success of the other. I hope this helps you the next time you’re deciding who you do and don’t want to work with!