In this podcast episode, I discuss the framework for deciding how aggressive to be with employer equity compensation.
Equity compensation discussed includes Options (at-the-money vs out-of-the-money) vs Restricted Stock Units (RSUs).
In situations where there is a vesting schedule (over a 3,4,5 year period), it almost always makes sense to take the equity compensation (vs cash).
However, I also discuss situations where taking cash would make sense based on personal financial circumstances.
Equity compensation is an amazing opportunity to concentrate and grow your wealth. You just want to make sure you have a plan in place to minimize the tax ramifications and diversify in the long term once you’ve built your foundation for financial independence.
Incentive Stock Options (ISOs) are one of the most complicated forms of employer stock compensation.
In this podcast episode, I discuss the basics of ISOs, how they function from a tax perspective and some major pitfalls to be aware of. One of the most common pitfalls people neglect is looking into potential alternative minimum tax (AMT) exposure when they exercise lucrative ISOs.
This happens when you are attempting to hold two years from the grant date and one year from the exercise date to benefit from long term capital gains. This can be a good strategy if you believe the share price will continue to rise and you want to reduce your tax liability.
However, the difference between the strike price and the fair market value of the stock on the day the option is exercised (known as the bargain element) is a tax preference item for calculating AMT.
Depending on how large your ‘bargain element’ is, you could be opening yourself up to a large AMT liability. You must be aware of this so that you’re not stuck with a massive tax bill come tax filing time (and have to find the cash on hand to pay it).
There’s a balancing act when it comes to divesting from concentrated stock positions via an ISO while being mindful of the tax implications.
In this episode, I also discuss the fear of missing out (FOMO) as it relates to owning employer stock (or any concentrated position for that matter), and why I’m a fan of regret minimization.
Anytime you’re selling off a concentrated position, there is an opportunity cost (which I like to refer to as investing FOMO). There’s always the chance that your stock (in this case employer stock) takes off and vastly outperforms the broader market.
However, you have to consider the downside as well, and that the individual security can massively UNDERPERFORM the overall market. You must have a long term financial plan that factors in your complete financial picture to determine whether you should (or need) to be taking on concentration risk.
ISO compensation is one of the most common windfalls I see. Especially, when you’re compensated from a private company that goes public, there’s the potential to become an ‘overnight millionaire’.
If you’ve experienced that ‘pop’, I discuss different ways to approach diversifying depending on your short and long term goals.