By Tricia Lepofsky
As we discussed in the first article in this series, equity compensation has become an increasingly popular option for many employers. It provides loyalty and employee benefits without the upfront cost required to increase base salaries or contribute to retirement plans. Last time we discussed the types of equity compensation you might receive; in this article, we’ll dive deeper and show you how to actually incorporate these options into your overall financial plan.
Many of our clients don’t know how to utilize, let alone maximize, equity comp to its fullest extent. Our team at KFA Private Wealth Group has experience with equity compensation models and can help guide you through the process. Consider these five tips on how to get started.
Where Does Equity Comp Fit In?
In practice, we’ve found that there are two main ways you can take advantage of equity compensation: cash flow planning and investment planning. Both options have several specific actions you can take to better utilize your equity benefits.
Cash Flow Planning
Cash flow planning involves budgeting and tracking income and expenses in an effort to better allocate your resources toward savings and other financial goals. For those who receive equity compensation, cash flow planning is key to incorporating your benefits into your overall financial plan.
- Fund Cash Flow Shortages
Over the years, total compensation packages have skewed more and more to the equity side, and less to high base salaries. This can create problems for many clients because as salaries remain the same, housing costs, child care costs, and the cost of daily goods and services continue to rise, leaving many clients to rely on their restricted stock vesting and/or bonuses to fill in the gaps.
If this sounds like you, consider creating a budget to help identify the monthly or annual shortage between your base salary and your non-discretionary expenses. Once this has been done, you can sell the number of company shares required to cover your shortfall.
It’s important to map this out prior to when you actually need the funds, so you can be sure your actions are tax-efficient. Accurately valuing your stock options or RSUs is also crucial. The last thing you want to do is sell, thinking that you will receive a certain amount, only to learn that your net earnings are much lower. This can be especially harmful if the purpose of the sale is to fund everyday living expenses.
- Fund Future Goals
Alternatively, if you do not need to sell the shares to fund your monthly cash flow, you can instead allocate them toward future goals, like large one-time purchases, home renovations, vacations, retirement savings, or education funding. It can be difficult to know which goal should take priority. If you’d like more information on how to decide which goals to fund, click here to read our other article about planning for multiple goals.
Once you’ve decided on a goal, it can be funded by selling the underlying stocks associated with employee stock purchase plans (ESPPs), employee stock options (ESOs), or vested restricted stock units (RSUs).
All these options should be well planned out since holding the stock for at least a year before selling will result in favorable tax treatment. It is crucial to incorporate equity compensation into your financial plan sooner rather than later. The tax consequences for these plans are usually years in the making, so you will want to plan far in advance to reduce your liability and maximize your benefits.
Investment Planning
While the cash flow planning strategy focuses on selling stock for funds that can be invested, the investment planning strategy focuses on staying invested in your company stock and how that can be used to maximize your future financial goals.
- Evaluate Your Company’s Performance
The first step you should take when incorporating equity compensation into your financial plan is to evaluate your company’s stock objectively. How is it performing relative to the entire industry’s performance? How is the industry performing relative to the market?
It’s easy to get swept up in rooting for the home team; after all, they are the ones who pay you. But would you buy your company’s stock if you didn’t work there? If the answer is no, then you probably don’t want to hold on to the stock for much longer than you have to.
- Buy and Hold
If you evaluated your company’s performance and decided that yes, you would buy the stock even if you didn’t work there, then consider using a buy-and-hold strategy. Not only will this give you the potential for growth, but it will also help you minimize tax liability by allowing any gains to be considered long-term. Keep in mind that this strategy should be periodically reevaluated to ensure it continues to make sense in your overall plan. It should not be a set-it-and-forget-it mentality, especially if it leads to an undiversified investment portfolio.
5. Consider Diversification
Speaking of diversification, it’s important to assess your overall risk level when you own large amounts of company stock. If it makes up more than 10% of your total investable assets, you are in a highly concentrated stock position. This is great if your company stock does nothing but grow for the next 20+ years, but the reality is most stocks have dramatic ups and downs that can wreak havoc on a financial plan.
In order to mitigate the downside risk associated with concentrated stock positions, consider the following options to diversify your portfolio:
- Exchange funds: A pool of stock shares from different companies; each investor contributes shares of a single company’s stock in exchange for shares of the diversified pool.
- Variable prepaid forward: A sale agreement where the investor agrees to sell their concentrated stock position in the future in exchange for a cash advance up front.
- Equity collars: These are created by selling a call option and using the funds to purchase a put option, which acts as a hedge against downside risk.
Learn More About Your Equity Compensation Options
If equity compensation makes up a large part of your employee benefit plan, reach out to us to learn more about your options. We at KFA Private Wealth Group work to ensure our clients have a clear understanding of their equity compensation and how it fits into their broader financial picture. Find out how we can help you start planning today. Email tricia@kfapwg.com or call 571-327-2222 to schedule an appointment.
About Tricia
Tricia Lepofsky is a financial advisor at KFA Private Wealth Group, a registered independent advisory firm founded on the premise of providing sound financial and investment advice. With a background in music education and opera, Tricia transitioned to the financial industry to help people understand what their money can do and feel more in control as they work toward their goals. Tricia is known for her attention to detail and her dedication to her clients and their unique financial challenges. She is passionate about building relationships with her clients and partnering with them as they walk through life’s milestones, keeping them accountable and motivated to pursue their goals. While she serves a diverse range of clients, Tricia uses her background of 18 years in the Washington National Opera and Washington Concert Opera to specialize in serving hardworking, intelligent individuals who have a connection to the arts. In her spare time, Tricia loves to travel with her husband, Mark, hike trails along the Potomac River or in the Blue Ridge Mountains, and support former colleagues by attending live performances of operas and musicals. To learn more about Tricia, connect with her on LinkedIn.
