![]() “To build wealth, you have to deal with tax consequences.” Nevertheless, Megan continued, it is important to model tax scenarios for your stock options and be prepared. In other words, chimed in Megan Gorman, the tax tail should not wag the option dog. “While taxes are key factors, it’s dangerous to base decisions principally on tax aspects and neglect coordination with goals and investment risk,” warned David Marsh. TaxesĪll of the webinar panelists agree that taxes should not be the principal driver of decisions. ![]() She uses these for her executive clients. “Have a strategy on selling stock and where the proceeds are going to be reallocated to.” When you have a strategy, one way to document it (and provide some protection from insider trading accusations) is with a Rule 10b5-1 trading plan. To lessen concentration risk and promote diversification, a strategy formulated with a financial advisor should also extend well beyond exercise, explained Megan. “If you show the best-case scenario, also show the worst.” “Create perspective,” asserted his fellow webinar panelist Megan Gorman, a financial advisor, founder of Chequers Financial Management, and a Forbes senior contributor. How can you balance the risks and the rewards? “Fundamentally, it is useful to base decisions with any type of equity award primarily on financial goals, timeframes for those goals, and the investment risk along the way,” explained David Marsh, Financial Planning Case Manager with Ameriprise Financial. That can give you yet another reason to wait on exercising your options until you have a solid post-exercise plan that includes selling shares for diversification. When you calculate your concentration level, you should include any vested stock options you have. A diversified stock portfolio helps to mitigate that risk. having too much of your net worth tied up in the stock of just one company. The webinar panelists also discussed the risk of overconcentration, i.e. Decisions about when to exercise must therefore factor in the outlook for the company’s stock price. If the stock price plummets below your exercise price, the value of the options vanishes (i.e. Stock options involve risks as well as rewards. These are the NQSOs that you might want to exercise and then immediately sell the shares. For instance, when the stock price is much higher than the exercise price, these options with a big spread have less leverage and smaller upside from stock-price increases. Funds that you would otherwise put into buying the company’s stock can be used for other investments, then directed later into the option exercise at a strategic moment for larger gains.īill’s approach, which he detailed in the webinar, applies various ratios that consider special factors to calculate the optimum time to exercise options. “An option’s value is enhanced by the ability to use the capital that would otherwise be invested in the stock for some other investment,” said webinar panelist Bill Dillhoefer, CEO of Net Worth Strategies (creator of the StockOpter decision-making tool for employee stock options).įor example, he explained that if your options have a 10-year term and the company’s stock price keeps rising, the options have growing tax-deferred value before you have spent any money on them. Financial advisors often liken stock options to an interest-free loan. ![]() Opportunity Cost And Exercise TimingĬonsider also the opportunity cost of exercising and holding NQSOs. In other words, the “Tao of Stock Options” might be the paradox that doing nothing for as long as possible could confer the greatest value. As long as the stock price continues to rise, thus increasing the spread over the exercise price, the leveraged value of the options grows without any tax hit, and your net after-tax proceeds will be larger. Before you exercise your options, their built-in value is subject to pre-tax growth that can be significant.įor all of these reasons, the panelists in the myStockOptions webinar agreed: often no advantage exists in exercising nonqualified stock options in a public company soon after vesting, paying taxes on the spread, and then holding the shares for long-term capital gains (unless special circumstances occur, such as job termination). Moreover, while cash bonuses and most other forms of compensation are taxable when you receive them, stock options defer taxes until exercise. Thus it’s important to think carefully about the right moment to make that move. Option leverage: a percent increase in stock price gives a much greater increase in option value Īs soon as you exercise the options and thus purchase actual shares of stock, the leverage ends. ![]()
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