Matthew Short, CFP®, MPAS®, AWMA®, CRPC®
Senior Wealth Manager
Equity compensation can be a powerful way to build wealth—if you know how to use it wisely.
Whether through stock options or restricted stock units (RSUs), your company’s equity plan offers you the chance to share in its growth and strengthen your long-term financial security.
Here’s a guide to equity compensation to help you understand how it works and navigate its complexities with confidence.
What Is Equity Compensation?
Equity compensation is a form of non-cash pay that gives you partial ownership in your company. Instead of just a paycheck, you may receive stock, stock options, or other equity-based incentives as part of your total compensation package.
Here are some of the most common types:
Stock Options: Stock options give you the right to purchase company shares at a fixed “exercise” or “strike” price within a certain period. Often, you can’t sell or transfer these options until they vest on a specified date. The two main types are incentive stock options (ISOs) and non-qualified stock options (NSOs), each with different tax implications. It’s important to know which type you’re receiving so you can plan accordingly with your accountant.
Stock appreciation rights (SARs): Similar to stock options, SARs allow you to benefit from any increase in the stock’s value above a set price within a defined period. If the value falls below that specified price, you won’t receive anything. However, if it rises above the price, you may receive cash or shares, depending on the terms of your agreement.
Restricted Stock Units (RSUs): These shares are granted to you according to a set vesting schedule or once specific milestones are achieved. Remember, you typically won’t have any stock ownership rights—such as voting or receiving dividends—until your shares have fully vested and been issued to you.
Employee Stock Purchase Plans (ESPPs): These programs allow you to purchase company stock at a discount during certain times of the year, typically through payroll deductions.
Performance Shares: This type of equity is awarded if you, your team, or the company meet specific performance targets, such as earnings per share (EPS) or total return of company stock in relation to an index.
Key Benefits of Equity Compensation
With careful planning and management, equity compensation can help you:
- Grow your wealth alongside your organization’s success
- Directly connect your hard work to your financial rewards
- Align your interests with your company’s long-term goals
- Unlock unique tax planning opportunities with the right timing
- Significantly increase your total compensation beyond your base salary
5 Common Mistakes to Avoid
Even the savviest professionals can make mistakes with their equity plans. Here are some of the pitfalls we see most often:
- Overlooking your vesting schedule. If you leave your company too soon, you risk forfeiting unvested shares.
- Getting hit with a surprise tax bill. Tax obligations can vary greatly for different types of equity compensation, so it’s crucial to know how taxes are determined and if and when you’ll owe them. For example, with NSOs, you may owe taxes when you exercise the options and when you sell them.1
- Failing to diversify your portfolio. Accruing too much company stock can increase your susceptibility to volatility, add unnecessary risk, and result in missed investment opportunities.
- Letting your options expire. If you fail to purchase shares during your exercise window, you may lose out on the money you would have earned.
- Ignoring blackout or lock-up periods. It’s important to be aware of trading periods that might prevent you from buying or selling company stock—such as before earnings season or if your organization is acquired or goes public.
How to Make the Most of Your Equity Compensation
To maximize your equity compensation, start by thoroughly understanding the type of equity you have, its tax implications, your grant details, and your vesting schedule. Remember, holding too much of your company’s stock can increase your risk, so it’s crucial to create a strategy for exercising and selling your shares that supports your financial goals, risk tolerance, and cash flow needs. By working closely with an experienced financial advisor and accountant, you can plan for taxes and diversify your investments while still sharing in your company’s growth.
Quick FAQ
What is equity compensation?
Equity compensation is non-cash pay that gives you a stake in your company through stock, stock options, or similar plans.
How do stock options work?
You get the right to buy shares at a set price. If the market price goes up, you can profit from the difference.
What does it mean to exercise your options?
Simply put, it’s buying company shares (and receiving equity) at the agreed-upon price.
Are RSUs taxable?
Yes — when your RSUs vest, they’re taxed as regular income based on their value at that time. If you sell them later for a gain, you’ll also pay capital gains tax on the realized gain from the sale of the stock. Selling within a year is taxed like income, but if you hold the shares for over a year, you’ll usually get a lower long-term capital gains rate.1
Consult with Experts
Wealth isn’t built by chance; it’s built by strategy.
Our financial planning specialists can help you determine the optimal time to exercise, hold, or sell your shares, optimize your portfolio, and ensure your equity and tax strategies are fully aligned with your long-term goals.
Reach out today for a personalized review of your equity compensation plan.
Sources
1 https://www.schwab.com/learn/story/equity-compensation-overview
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This presentation is not an offer or a solicitation to buy or sell securities. The information contained in this presentation has been compiled from third-party sources and is believed to be reliable; however, its accuracy is not guaranteed and should not be relied upon in any way whatsoever. This presentation may not be construed as investment, tax or legal advice and does not give investment recommendations. Any opinion included in this report constitutes our judgment as of the date of this report and is subject to change without notice.
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