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Retirement income planning with stock options

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Retirement income and financial planning require additional considerations when you own significant assets in the form of stock options. The most common types of stock options, “grants,” are non-qualified options (NSOs) and restricted stock units (RSUs). Planning strategies will differ depending on the type of options owned with more flexibility available to owners of non-qualified options (NSOs).

Vesting

Non-qualified options (NSOs) typically vest over time and have a “strike price” that the owner pays in order to purchase or exercise shares. Restricted stock units (RSUs) usually vest over a specified schedule. The strike price is zero, with the owner paying nothing for the shares and no control over when the options are exercised. Rather, they automatically “vest” according to a schedule. With RSUs, the decision of when to sell the shares becomes the focal point of establishing a strategy. With NSOs, the owner can exercise the options immediately when vested or any time up to the expiration date. If you receive multiple non-qualified option grants, you may have various vesting dates and expiration dates.

Continued Employment

The “grant” of stock options is a benefit designed to encourage continued employment with your employer. With NSOs, determine if you have a limited amount of time to exercise options if your employment is terminated. RSUs generally expire at termination. However, you may want to inquire with your employer to learn if they provide an accelerated vesting schedule.

Taxation

NSOs and RSUs are both taxed as ordinary income. Because NSOs provide latitude regarding when they are exercised, you have more control of the year that you incur taxation. With NSOs, you are taxed on the difference between the current value and the option strike price. Once you own NSOs, future gains or losses will be taxed at capital gains tax rates. Holding exercised shares for at least one year can provide preferential long-term capital gains tax rates. If you hold shares for less than a year, short-term capital gains tax rates are incurred, equivalent to higher ordinary income tax rates. RSUs do not allow for control of the year that you incur tax, becoming taxable the year in which they vest. However, like NSOs, once you own RSUs, they provide preferential long-term capital gains tax treatment, if held for one year.

Developing a strategy

Develop a strategy that assists with achieving your financial planning goals. With NSOs, ideally you exercise the options, incur the tax between the strike price and current value. Then, hold shares for at least one year to minimize taxation. Yet, if you do not have confidence the stock price will hold, it can be best to sell at a higher price, even incurring more income tax. Creating a plan of when to exercise some options and sell shares, allows you to spread the corresponding tax over numerous years. The strategy for RSUs focuses on when to sell vested shares, based on the expectation of the stock value and personal objectives.

Consider diversification and what percentage of your long-term investable assets should be comprised of employer stock. Accelerating deductions, increasing your contributions to 401(k) and HSA accounts in years that you are incurring more income tax from stock options, may assist in reducing overall taxable income. Build flexibility into your plan for exercising options, incurring tax, monitoring stock value and review frequently.


Kevin Kingston, CLU, is managing director and financial adviser at Savant Wealth Management; savantwealth.com

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