If you are on the receiving end of an equity compensation award, you may be overwhelmed by the amount of new information, jargon, and rules coming your way. You might also feel uncertain about how new equity grants and vesting schedules should fit into your existing financial plan.
To begin, you can start by focusing on a few fundamentals about how your specific benefits work. Regardless of what kind of equity compensation you have, two critical components to understand will be grant dates and vest dates.
Here’s what actions you can consider taking when each of these important events occurs.
What Happens When Your Equity Compensation Is Granted
Your company can grant equity compensation for essentially any reason it chooses, but it’s most commonly offered as part of a hiring package, a company benefit, or a reward for meeting a performance metric.
Generally speaking, receiving an equity compensation grant is a non-taxable event. In many cases, you may not be able to do anything with that grant right away because of another important date: the vest date.
Grants are often issued with a vesting period that you must meet before the awards vest, and before you can access the potentially valuable benefits of the grant. That doesn’t mean, however, that you should just ignore your grants.
Important Information to Know Once You Receive a Grant
When you receive a grant, you should note some key facts and dates associated with your equity compensation award. Some of these key dates and key facts include:
The type of award you are receiving (i.e., stock options or restricted stock)
When your awards vest
When your awards expire (for stock options)
What the strike price of the award is (for stock options)
What happens to your award if you leave your company
What happens to your award if the company merges, is sold or goes through some other change of ownership.
You can usually obtain this information by reading through your grant agreement and your company stock plan document. This information can be helpful in most appropriately integrating your equity compensation into your financial plan.
You can use this information to build a financial plan that integrates your equity compensation. The goal here is to be proactive in making decisions, rather than waiting and then being forced to simply react (or follow the only path available due to deadlines or other restrictions).
What Happens When Your Equity Compensation Vests
What happens when your equity compensation vests will depend on the type of grant you receive.
When your restricted stock vests, shares of stock (assuming a stock settlement) are commonly deposited into a brokerage account for your benefit at the company custodian of choice. Don’t be surprised if the number of shares deposited is less than the number of RSUs that vested.
A taxable event occurs when your RSUs vest. Unless you have nominated to sell shares to cover tax (this won’t cover the tax in Australia), you will need to manage the tax.
If you receive 1,000 RSUs that have fair market value of $50 per share when they vest, the total taxable value of your RSUs when they vest is $50,000. That $50,000 is reportable as taxable income to you in the year the shares vest.
This value will be taxed like your other earned income.
What to Know If You Have Vested Non-Qualified and Incentive Stock Options
Unlike RSUs, vesting isn’t a taxable event for non-qualified stock options (NQSOs) and incentive stock options (ISOs). With options, vesting simply means that you can act upon your ability to exercise that option if you chose. You don’t create a reportable tax event until you exercise.
If you didn’t act on an early exercise (or didn’t have the ability to do so), then the option vest date is your first opportunity to take action. In general, you can do one of two things at this point: do nothing and wait to exercise at a future date, or exercise your options now.
Determining the right action can get complicated. To decide, you should consider what the value of the award is, how this fits into your other equity compensation, what activity on your options may have already occurred, what the tax bill may be, what your own investment risk tolerance looks like, and your overall financial planning goals and objectives.
If you exercise NQSOs, the reportable tax event looks very similar to RSUs above. The value created via the exercise is taxable as ordinary income. Your company will typically withhold the taxes you owe via a share-withholding or sell-to-cover. They’ll then deposit the net amount of shares into your brokerage account.
If you have ISOs, the tax rules associated with exercising get much more complicated. You may need to address the alternative minimum tax, ordinary income tax, and cash flow constraints associated with a taxable event for which no tax is withheld (even if you sell your ISO shares).
Equity Compensation When Awards are Granted and Vested
If you receive equity compensation from your employer, familiarize yourself with the terms “granted” and “vested.” By understanding what each means for your equity, you can better integrate those rewards and shares into your financial plan.
Being proactive here will hopefully lead you to a better, more complete, and accurate decision to get you to your desired financial outcomes