Equity Compensation: A Guide for High-Level Executives
James Zahansky, AWMA®
Principal/Managing Partner, Investment Advisor & Chief Goals Strategist
If you’re a high-level executive (or are just stepping into the role), you likely have been offered equity compensation as part of your overall compensation package.
Here are a few basics that anyone who has, or is being offered, equity compensation should know.
Equity compensation comes in the form of a share of the company’s future profits through various stock options, performance shares, or whatever other arrangements your company has decided on. It can provide a great opportunity to build your own wealth as you work to grow your company – the better your company performs, the more you’ll earn in equity. But it does come with some risk, and strategic financial planning is also crucial to maximizing this type of benefit within the context of your overall compensation package and financial goals.
Pros of Equity Compensation
Being offered a portion of your company’s future profits is an exciting opportunity and an important incentive to stick with one company for many years. Dependent on the success of the company, there’s an opportunity for these stock options to provide a bigger payout than a standard salary would.
Cons of Equity Compensation
But as is with any stock option, where there’s a chance for reward, there’s risk as well. Compensation via stocks or other equity compensation could leave your pay at the mercy of the market and the company’s performance. And while this is a risk that’s understood when agreeing to the terms of your compensation package, it can be hard to remember nothing is guaranteed.
It’s also important to understand the potential tax implications that equity compensation may have on your future earnings. These implications will vary dependent on the structure and specifics of the company offering the compensation. In some cases though, cashing out on your stock options may look like a big payout on paper, but taxes could be taking a sizeable chunk out of the check you were expecting to receive.
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Types of Equity Compensation
Equity compensation typically comes with a vesting schedule, a period of time in which stocks fully become yours. This schedule will depend on the company and equity type. Some companies may not require a vesting schedule, though this is either a business choice or a result of their available stock option. There are also different types of equity compensation, each with a different set of opportunities, costs and taxes associated with it.
Here’s a high-level overview of equity compensation types – consider their advantages and disadvantages when deciding whether equity compensation is right for you.
- Stock Options: With stock options, you’ll have the opportunity to purchase a limited number of stocks at a reduced price. After your vesting period, these stocks fully become yours, allowing you to keep or sell them. Be aware, stock options are typically available for a limited amount of time and follow different tax rules between pre-vested and vested stocks. It’s important to note that an employee is not considered a stockholder if they take this option.
- Non-Qualified Stock Options (NSOs): These are similar to standard stock options, but with a few tax differences for employees. Owners of NSOs may have to pay taxes under two circumstances: income tax when they purchase a non-qualified stock; and capital gains tax if the stock is held for a year or more.
- Incentivized Stocks: Like non-qualified stock options, incentivized stocks are similar in function to standard stock options, with a different set of tax rules. You will only need to pay capital gains taxes on this stock if it is sold after a set window of time. Otherwise, you may come across additional tax penalties.
- Restricted Stocks: Unlike other stock options, which you may receive before your vesting schedule provides full control, restricted stocks are limited by the employer based on your vesting schedule. Instead, you will receive these stocks when they vest. The rate at which restricted stocks are received will depend on the company, just as the vesting schedule does.
- Performance Stocks: As the name implies, employees receive performance-based stocks according to a set of goals. These goals may vary and will depend on your company.
A Final Word
Understanding the differences between stocks can help you determine the value and tax implications of equity compensation. Remember to keep this list in mind when offered stock options by an employer. If you’re unsure of what the best move may be for your current and future financial needs, get in touch with us at Weiss, Hale & Zahansky Strategic Wealth Advisors and we can help unpack your options. We partner with business executives to maximize compensation package benefits within a comprehensive and strategic financial process designed to help you Plan Well, Invest Well, and Live Well™, now and in the future.
Presented by Principal/Managing Partner James Zahansky, AWMA®. Securities and advisory services offered through Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser. These materials are general in nature and do not address your specific situation. For your specific investment needs, please discuss your individual circumstances with your representative. Weiss, Hale & Zahansky Strategic Wealth Advisors does not provide tax or legal advice, and nothing in the accompanying pages should be construed as specific tax or legal advice. 697 Pomfret Street, Pomfret Center, CT 06259, 860-928-2341. http://www.whzwealth.com.
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