Whether your company issued you stock options as part of your compensation package, you invest in company stock within your 401(k) plan, or you have the option to purchase company stock in an employee stock purchase plan (ESPP), there are several considerations you need to take into account if you are going to effectively manage your holdings.
You may feel that your company stock is more secure than other investments in your overall portfolio. It's easy to become myopic when it comes to company stock - just because a company issues your paycheck, there is no reason to treat that stock any differently than your other holdings. Several recent corporate bankruptcies have shown us the danger of over reliance on company stock. Losing your salary and your equity can be financially devastating. (For related reading, see: The Best Strategies to Manage Your Stock Options.)
Set An Investment Limit of 10%
Most experts believe in exercising caution when it comes to the extent your position in relation to total wealth. If your employer stock holdings exceed 10% of your total portfolio, it is time to evaluate your position. Some experts even say 5% is the red-flag point, given that the company is also responsible for your salary.
Also evaluate a company stock position that represents more than 10% of your 401(k) plan. Diversification is essential to maintaining your retirement investments for when you need them most. Many companies have historically favored offering company stock in 401(k) plans, although employee lawsuits resulting from corporate bankruptcies have recently curbed enthusiasm for this practice.
If your company stock does currently exceed 10% of your total portfolio or 401(k), then it is time to look at ways of reducing your holdings but before selling any of this be sure you evaluate the benefits or drawbacks of a net unrealized appreciation (NUA) strategy. (For more from this author, see: 3 Factors That Impact Your Stock Compensation.)
Evaluating Tax Implications
You will need to evaluate the tax implications of any sales both immediate and delayed. Your tax exposure will depend on your individual equity compensation package and how you divest your shares. Some general considerations to take into account include:
- You may have received incentive stock options (ISOs), non-qualified stock options (NQOs), or both. While mechanically similar, these have different tax implications.
- ISOs have the most tax flexibility, potentially being treated as long-term capital gains tax, although there is a two-year rule that can affect when you can divest them. In a volatile market, you may also find that the alternative minimum tax (AMT) is triggered at time of exercise on ISOs.
- NQOs are not subject to the AMT. When you exercise a nonqualified option, you must pay ordinary income tax rates on the difference between your price and the market value.
- Your company may award you with restricted stock to encourage company loyalty, which will be taxed as wages - but not until vesting date so you must plan ahead for this tax.
- With restricted stock, you may decide to elect current taxation rather than paying at a point in the future. To do this you will need to file a written 83(b) election with the IRS within 30 days of receiving it.
With good advice, you may be able to take advantage of tax advantages and plan to avoid potential pitfalls.
Understand Your Insider status
If you are considered to be an "Insider" and/or subject to Rule 144 (defined as a director or senior officer, owners of more than 10% of a company’s voting shares, or those in possession of material non-public knowledge for trading purposes), remember that the Securities Exchange Commission (SEC) has compliance controls around the sale of securities that may bar you from selling stock. To avoid accusations of Insider trading, you may be able to execute a 10b5-1 trading plan for selling your stock, which allows you to sell a predetermined number of shares at fixed intervals, and diversify your holdings over time in a legal and compliant manner.
Familiarity with your company can prevent you acting as you would for any other stock, but don’t allow yourself to become complacent when it comes to viewing your employer stock holdings as just one part of your overall portfolio.
Diversification is no guarantee of enhancing your overall returns but it may mitigate some of the risks of over reliance on your company’s stock performance. We would always recommend that you talk to an experienced advisor when considering your position as there are a multitude of tax and legal implications around managing your employer stock holdings, as well as your own personal circumstances to take into consideration. What may be advisable for one individual may not be applicable, advisable - or even legal - for you. (For more from this author, see: New Job? Don't Forget Your Company Stock Options.)
*This information is not intended to be a substitute for specific individualized tax or legal advice. We suggest that you discuss your specific situation with a qualified tax or legal advisor.