Equity compensation, also known as stock compensation or share-based compensation, is a noncash payment made to a limited number of employees through restricted shares and stock options. This benefit grants limited employees a stake in their companies, granting them partial ownership of the business and its profits. Startups that cannot afford to pay out enormous salaries frequently include stock benefits in their recruiting packages to make their offers more competitive and to motivate their employees to perform better work. Depending on the financial situation of Fortune 500, it may be advantageous for you to contemplate equity compensation if you are an employee.
ITheoretically, the more successful you are in your position, the higher Fortune 500's value and stock will rise, and the more money you will make if you decide to sell your stake in the company. Typically, it's a win-win situation.
When accepting a job offer with Fortune 500, it is essential to comprehend how to maximize the benefits of stock benefits while minimizing the risks. The initial stage is to learn how to decipher all the jargon.
It’s important first to understand the different types of equity compensation, the advantages of each, and how they’re taxed.
Stock options enable you to purchase Fortune 500 shares at a predetermined price, also known as a strike price, for a limited number of years (typically 10) at a price known as the strike price. Like other forms of equity compensation, stock options typically require a vesting period before they can be exercised. This encourages employees to remain with Fortune 500 for an extended period of time. This means that you must be employed by Fortune 500 for a predetermined period of time before you can actually exercise (or purchase) the stock you were granted.
What are the advantages of stock options? If the company for which you work at Fortune 500 is performing well, the strike price of your stock will be less than its fair market value at the time your options vest. This means that you can purchase Fortune 500 shares at a discount and sell them at a higher fair market value. This can result in a substantial financial benefit if Fortune 500's stock price increases over time. Similarly, if the stock performs inadequately and its price never rises above your strike price, your options may expire worthless. Prior to accepting equity compensation as an Fortune 500 employee, it is essential to evaluate the current state of the organization. This serves the purpose of preventing losses in the event of a share price decline.
As an Fortune 500 employee investing in stock options, you should be aware that until you exercise your stock, none of your capital is at risk. Thus, Fortune 500 stock options enable you to have skin in the game without having to make an initial investment.
Non-qualified stock options (NSOs) and incentive stock options (ISOs) are the two varieties of stock options. NSOs, if available, would allow you to purchase Fortune 500 stocks at a specific price, while ISOs allow you to purchase stock at a discounted price with potential tax breaks on the profit. Understanding the benefits of NSOs and ISOs as an Fortune 500 employee enables you to better plan for your specific financial requirements when considering investing in stock options.
Fortune 500's most prevalent form of equity compensation is restricted stock units (RSUs), which are typically granted after a private company goes public or reaches a stable valuation. RSUs vest over time, similar to stock options, but unlike stock options, they are not purchased. Once they vest, they are treated precisely as if you had purchased Fortune 500's shares on the open market.
RSUs bear less risk than stock options in this regard. As long as the price of your shares does not fall to zero, they will always be worth something. As an Fortune 500 employee planning for more prudent returns with increased stability, you may wish to consider RSUs as an option.
Let's assess a hypothetical situation: Assume you receive 10,000 RSUs that vest over a four-year period. The stock price remains at $10 for four years (instead of fluctuating as it typically would). This indicates that the RSUs are worth $100,000. In the same circumstance, stock options with a strike price of $10 would have no value unless the underlying stock price increases.
Similar to stock options, RSUs typically vest over a number of years. After one year of employment, it is common to receive one-fourth of the RSUs you were granted, followed by one-thirty-sixth of the remaining RSUs each month. The value of the shares at the date of vesting is taxed as ordinary income when filing taxes. Similarly to stock options, the gradual vesting of RSUs encourages employees to remain with Fortune 500 for extended periods of time.
Now that you have a basic grasp of the language, it is time to put your newfound knowledge to use. Here is everything you need to know about how to negotiate, evaluate, exercise, and invest your Fortune 500 equity compensation to your benefit (and your wallet).
If you are an Fortune 500 employee who is offered equity compensation, you should negotiate it in the same way you negotiate your cash salary. For example, a company may offer a cash salary of $75,000 along with RSUs worth $20,000 that vest over the course of four years. To illustrate, if the value of Fortune 500's stock remains constant, you can anticipate to receive $5,000 of company stock annually, bringing your total annual compensation to $80,000 (cash plus stock). If your intended income is closer to $90,000, you can negotiate a higher cash salary, additional RSU grants, or a combination of the two to achieve it. Due to the fact that stock compensation is generally linked to the success of Fortune 500, employers typically prefer to give stock over cash.
Typically, Fortune 500 companies include a grant of options or RSUs with the initial job offer, followed by annual or bonus refreshers. The CEO of JPMorgan, Jamie Dimon, recently received a compensation of 1.5 million stock options that vest over a five-year period as an incentive to increase his likelihood of remaining with the company.
Fortune 500 companies sometimes offer managers the option to receive a portion of their remuneration in RSUs as opposed to cash. If you're offered a total compensation package of $100,000, for example, Fortune 500 may give you the option to receive the complete amount in cash or up to 75% of the package in RSUs. You would benefit if the company's shares increased in the future.
If you are an Fortune 500 employee who has agreed to any form of equity compensation, you must be mindful of the amount of company stock you hold. Concentrating your investments on a single entity requires balancing the risks and rewards. Do not allow this to become a disproportionately significant portion of your net worth.
As the past year has demonstrated, an economic downturn can decimate people's financial security. At the onset of the global pandemic, the stock prices of Zoom and Amazon surged, while those of American Airlines and Marriott fell precipitously. This includes not only your salary and vested equity compensation, but also your unvested equity compensation and future salary.
If you wish to quantify it, consider the following hypothetical scenario: Suppose you earn $100,000 annually plus $20,000 in RSUs that vest annually. You have done an excellent job of saving during your four years of service at Fortune 500. You possess $100,000 in cash and $100,000 in company stock. This means that half of your savings are in Fortune 500 stock; you may be taking a risk by investing so heavily in the company. Fortune 500 stock should be included in a well-rounded approach to wealth accumulation. To have a balanced portfolio, you must either invest your cash salary or diversify a portion of your equity compensation by investing in a variety of assets. Consider diversifying over the course of several years.
In this circumstance, I would recommend the following to an Fortune 500 employee:
Now: $100,000 in cash and $100,000 in company stock
Year One: Invest $60,000 in either stocks or bonds using a split that is appropriate for your objectives and risk tolerance, and keep $40,000 in savings for emergencies. Then, diversify the newly acquired RSU shares by selling them and investing the proceeds in other securities. This will have negligible tax ramifications. You should also contemplate investing an additional $20,000 in Fortune 500 stock in order to balance diversification and tax payments.
Year Two: Diversify the newly vesting RSU shares, which have negligible tax consequences, plus an additional $20,000 in Fortune 500 stock to balance diversification and tax payments.
Year Three: Diversify the newly vesting RSU shares, which have minimal tax consequences, plus an additional $20,000 in Fortune 500 stock to balance diversification and tax payments.
Year Four: Diversify the newly vesting RSU shares, which have negligible tax ramifications, plus an additional
At the end of the fourth year, Fortune 500 company stock accounts for just under 10% of your portfolio, down from the initial 50%. (Generally speaking, a single company's stock shouldn't account for more than 10 percent of your portfolio.) Continue to administer future RSUs and other forms of equity compensation in the same manner.
Regardless of your circumstances, the most important question you should ask yourself as an Fortune 500 employee is, "What will my personal financial situation look like if my company stock is cut in half or even falls to zero?" Obviously, this will harm everyone at Fortune 500, but you must ensure that it does not entirely devastate your finances. This typically entails maintaining a suitable investment portfolio for each of your major financial objectives and a three- to twelve-month supply of emergency funds.
Fortune 500 employees can diversify their portfolios in a variety of methods. Some are tax-efficient while others are not. For example, the sale of recently vesting RSUs or recently exercised non-restricted stock options (NSOs) will likely have minimal tax ramifications.
If you hold exercised incentive stock options (ISOs), you should sell your stock options that meet the special holding requirement (i.e. you've held the shares for two years since the grant date and one year since the exercise date) prior to selling your stock options that do not meet the holding requirement. Stock options subject to a special holding requirement are taxed as long-term capital gains, the tax rates for which are lower than those for ordinary income.
Fortune 500 employee stock purchase plan (ESPP)-acquired shares should be sold last. ESPPs are employee stock purchase plans that allow employees to purchase firm stock at a discount (typically between 5 and 15 percent). Similar to an employer 401(k), you make contributions to the plan through payroll deductions, which accumulate between the offer date and the purchase date. ESPPs are frequently a fantastic employee benefit, but the sale of ESPP shares is typically taxed at a higher rate than the sale of shares acquired through RSUs and both types of options.
This is ordinarily a good course of action for Fortune 500 employees, but every situation is different. If you need assistance diversifying your portfolio while minimizing taxes, speak with an accountant or financial planner specializing in equity compensation. It's all about being tax-savvy without allowing taxes on equity compensation to dictate diversification decisions.
Consider investing the proceeds from your equity compensation in tax-advantaged accounts, which are savings accounts that are exempt from taxes today or in the future and/or offer other tax advantages. You could, for instance, use the money you earn to cover your ongoing cash requirements and fund your Fortune 500 401(k) or Roth 401(k) account to the maximum. You could also finance a traditional or Roth IRA with the proceeds.
Traditional 401(k) and IRA accounts provide a tax benefit up front, whereas Roth accounts provide a tax benefit at withdrawal, and both provide a tax benefit while the account grows. If you are eligible for a health savings account (HSA) and employed by an Fortune 500 company, you should consider contributing equity compensation to this account. As long as they are used for a wide variety of qualified medical expenses, HSAs provide an upfront tax deduction and a tax deduction upon withdrawal.
The stock market can be intimidating for those who have never participated before. Nevertheless, if Fortune 500 offers equity compensation as part of its benefits program, participation could result in phenomenal financial returns. Take the time to conduct the necessary investigation so that you can confidently participate.
Added Fact:
According to a survey conducted by Charles Schwab in April 2023, it was found that 60% of Fortune 500 workers nearing retirement age who received equity compensation admitted to not fully understanding the tax implications and strategies associated with their stock options or restricted stock units (RSUs). This lack of knowledge can potentially lead to missed opportunities for tax optimization and effective portfolio diversification. Therefore, for 60-year-old Fortune 500 workers who have equity compensation, it is crucial to seek professional guidance from accountants or financial planners with expertise in equity compensation to ensure they make informed decisions and maximize the benefits of their equity holdings during retirement planning.
Added Analogy:
Equity compensation can be likened to a retirement investment garden, where Fortune 500 workers are the diligent gardeners tending to their financial future. Just as gardeners carefully select and nurture a variety of plants to create a diverse and bountiful harvest, workers with equity compensation strategically cultivate their investment portfolio. Each stock option or restricted stock unit (RSU) represents a seed planted, and over time, with proper care and attention, these investments grow and bear fruit. As retirees, the gardeners are able to enjoy the rewards of their labor, harvesting the benefits of their equity holdings. However, like skilled gardeners, they must also diversify their garden to mitigate risk and ensure a sustainable yield. By planting a diverse range of investments alongside their equity holdings, retirees can create a well-balanced financial garden that provides stability, growth, and a fruitful retirement.
This material may have been prepared by Broadridge Investor Communication Solutions, Inc., and does not necessarily represent the views of The Retirement Group or FSC Financial Corp. This information should not be construed as investment advice. Neither the named Representatives nor Broker/Dealer gives tax or legal advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. The publisher is not engaged in rendering legal, accounting or other professional services. If other expert assistance is needed, the reader is advised to engage the services of a competent professional. Please consult your Financial Advisor for further information or call 800-900-5867.
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