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What is a Nonqualified Stock Option? Episode 20

Welcome to the  Equity Compensation Guidebook and episode 3 of our mini-series. Today I will break down precisely what a non-qualified stock option— commonly referred to as an NSO— is. I won’t be covering incentive stock options since 95% of stock options are non-qualified and I don't work with any clients who have ISO's. If I tried to explain the ISO I'm sure it would be a mess since I don't cater to those clients. NSOs are not super complex. The complexity with NSOs comes into play when you exercise the options and while we'll touch briefly on that, I'm going to save that minutia for another episode.  

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

  • What is an NSO? [1:19]

  • Important time periods when it comes to NSOs [2:49]

  • When to exercise and how to pay for your options [4:05]

  • What to expect when it comes to taxes [6:16]

  • This week’s FLASHBACK [7:28]

Understanding non-qualified stock options

Non-qualified stock options are named as such because there are no special tax rules applied to them. Basically, they do not qualify for any special tax treatment. An NSO is simply an agreement that creates terms that allow you to buy a specific number of shares, at a set price, during a determined timeframe. The details are included in your employer's stock plan document, be sure to get a copy of it so that you know the rules unique to your situation. NSOs are a way for you to directly participate and hopefully benefit from your employer's success. Assuming the price of the stock goes up, and that detail is important because there is no financial risk to you until you exercise the options. Check out the episode for more details!

Don’t be part of the 11%, you can’t turn back time when NSO’s are involved!

When it comes to NSOs there are a couple of time periods to be aware of. The first is vesting. This is that period of time before you can actually exercise your options. However, the more important time period is the overall exercise period. This is typically 10 years in length. If you do not exercise your NSOs within this period you lose your options. That's it, GONE! The most recent data shows that 11% of in the money options are allowed to expire every year. That means options above the grant price were NOT exercised! There may be a reason why someone would let these in-the-money options expire, but I've never heard a good one. Odds are it happened because the options holder and/or their financial advisor we're not paying attention. What a costly mistake! Don’t let that happen to you!

This week’s FLASHBACK: The MVP of a snowstorm

Neither snow, nor rain, nor heat, nor gloom of night keeps couriers from the swift completion of their appointed rounds. You may think I am talking about the post office but in fact, I am talking about the paper delivery boy in the ‘80s. I can’t remember the specific year but it was a winter in the early ‘80s and we had a massive snowstorm. We had close to two feet in one day! Schools were closed for 3 days. The only traveling I did in that time was the few blocks I walked to do my paper route. I have no idea how the delivery trucks got through on that first day! I didn’t think much of it until I read the letters to the editor where subscribers mentioned that even though they didn’t get mail for a day or two it didn’t stop the kids from completing their routes. I thought it was pretty cool that a bunch of kids were able to complete a task that the adults couldn’t get done. 

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.