Equity Compensation—It's Not Just Fun Money

January 17, 2024 Patrick Means
When your employer grants you shares of stock, it can feel like a bonus. But it's more than fun money; it's a chance to build your financial future if you manage it right.

More and more companies are sweetening the deal for employees by offering equity compensation as part of a salary package. And a lot of people are tempted to see this type of compensation as a sort of bonus—a cash windfall to spend freely. 

But equity compensation isn't just money. It's a chance to share in the ownership—and growth—of the company you work for. Usually, it comes in the form of shares of company stock. So what can this mean for you? Let me give you a personal example. 

A few years ago, I made a big life change—new position, new city, new house. The only possible downside was that I'd initially be making less money. Okay, I thought, I can handle that for a while. But I needed to plan on how I was going to fund a down payment on the house. Fortunately, as part of my compensation in my previous role, I'd been granted company shares. I'd hung on to them and, luckily, they'd increased in value. Now I could sell these shares to cover the down payment.

Sounds simple on the surface. But equity compensation can be tricky, and it takes thought and planning to make the most of it. Here are three things to focus on. 

What's the real value of what you have?

Employers use equity compensation to not only attract, but also to retain talent, so company stock is usually granted over time. Let's say you're offered a $10,000 grant over four years and the price is currently $25 per share. This means you have a grant of 400 shares. But you don't get those shares all at once. At the end of year one, you'd get 100 shares. Same at the end of years two, three, and four. This is called vesting, and you'd need to stay with your employer for four years to get the full grant. 

But is the grant really worth $10,000? If the stock price goes up, it could be worth a lot more. Of course, it could also go down and be worth less. 

Now let's say you get this same grant each year. Your ownership of the company could increase significantly—and so could the value of your shares. This is where thoughtful portfolio management becomes especially important.

What do you want to do with it?

When your shares vest, they're placed in an account for you. Now you need to decide whether to hang on to them or sell. While it might be tempting to sell right away and go on an awesome vacation or buy a new car, take a step back. What are your short-term needs? Your long-term goals? Don't think of equity compensation as fun money, but as an important part of your total income. 

Prioritize. Do the kids need braces? Do you have student loans or other debt to pay off? Maybe it's wise to sell a portion of your shares. Are you saving for college tuition or a home down payment like I was? Could be best to hang on to the shares.

Another important part of the decision to sell or not is how much of your portfolio your company stock represents. The old adage "don't put all your eggs in one basket" applies here. If I owned company stock that represented more than 20% of my overall portfolio, I would sell a portion and spread my money out among other investments. Others may be more comfortable holding no more than 10 to 15%, and that's just as acceptable. Your company stock may be soaring now, but there's no guarantee the arrow will keep going up and to the right. Best not to have your career and your financial life tied up in the same place. Create a limit that is comfortable for you and stick to it.

How and when will you be taxed?

Taxes can come as a surprise. Equity compensation comes in different shapes and sizes with different tax rules and regulations, but let's discuss Restricted Stock Units (RSUs) since they are one of the most common. The RSU value is considered income and shows up on your W-2 once the shares vest and are delivered, so you'll pay applicable Social Security and Medicare taxes on the amount as well as federal, state, and local taxes. Your employer will withhold a certain percentage to cover these taxes. Gotcha #1 is that you may receive less than you expected due to these taxes. Gotcha #2 is that the percentage withheld may not be enough and you end up owing more at tax time.

And then there's potential capital gains taxes. In my case, I held the shares for more than five years, so I paid long-term capital gains which tend to be lower than ordinary income taxes. If you sell within a year of receiving the shares and the stock has gone up, you'll pay short-term capital gains, which are taxed at your ordinary income tax rate.

It's not only financial—it's emotional.

There are lot of financial considerations, but when it comes to selling your company stock, there's also an emotional side. The company has given you part ownership of the firm, and you believe in its potential, so it can feel disloyal to sell. I understand that. But loyalty and taking care of yourself aren't mutually exclusive. When I sold, it was hard to say goodbye to the shares, but it was the right timing for me. It helped fund the down payment I needed, and it was a tax-smart move. 

As much as you believe in your company, you can't predict the future. Things can go down as quickly as they go up. You don't want to put yourself at a disadvantage. The way to win is to take the profits when the time is right for you and have a strategy to preserve the capital you've been able to amass. 

That's why it's good to talk with a financial advisor. An advisor can help you understand what you have and develop a plan to make the most of it. And isn't that what your employer would want? Because if you feel financially set up and secure, you'll be an even better asset to your company. 

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The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision. All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness, or reliability cannot be guaranteed. Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

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Diversification strategies do not ensure a profit and do not protect against losses in declining markets.