Employee stock options can be a valuable part of a Stryker employee’s total compensation. They enable employees to benefit from the company’s upside and can create meaningful wealth. However, stock options are more complicated than just owning company stock and they have unique tax treatment. This article will go over five key mistakes Stryker employees make with their options and steps you can take to avoid them.
Not viewing the options as part of your total investment portfolio
Once your options vest, they may have value depending on the current value of Stryker stock and the strike price of your options (as long as the current price is above the strike price, the options can be exercised for a profit). Over time, a rising stock price results in an increasing value of your options. As more options vest and you receive additional grants, your options can become a substantial portion of your investment portfolio.
It is important to recognize that options are part of your overall portfolio like other investments in the stock market, even though they may feel different since you didn’t explicitly purchase them and you may not be paying close attention to them.
When looking at the options as part of your overall portfolio, these are some key considerations:
- Are you comfortable with your level on concentration in your company stock? We discuss the topic in this post – Do You Own Too Much Company Stock?
- Are you comfortable with the overall risk level of your portfolio? Stock options act similarly to a leveraged stock position, meaning their value moves more than the underlying stock and are thus riskier than just holding the stock. What is your overall asset mix between stocks, bonds, cash, real estate and other assets?
Ignoring the tax consequences of exercising options
The taxation of stock options is more complicated than that of other stock compensation such as Restricted Stock Units. However, stock options do allow the holder to exercise more control over their tax impact. For this discussion, we will focus on non-qualified stock options (NQSOs).
NQSOs have unique tax treatment. These options are a form of compensation; however, you are not taxed when they are awarded to you nor when they vest.
For these options, you are taxed when you exercise the options. To determine your tax bill, first multiply the spread (the difference between the exercise price and the current stock price) by the number of options you exercised. That value is treated as ordinary income at the time of exercise. From this point on, the resulting shares are treated as a regular stock holding with capital gains treatment of the gains or losses when sold.
Since these options are taxed when exercised, the owner of the option has more control over the tax consequences as they can decide when to exercise the options.
Things you may want to consider when exercising NQSOs:
- What does the rest of the tax picture look like during that year?
- Will exercising these options push me into a higher tax bracket? Will I be paying the net interest income tax of 3.8%?
- What do I expect my income to be in future years?
- Would I be better off exercising these options over a multi-year period?
- How much in taxes is my company withholding?
Not reading the plan document and grant agreement
When options are granted to you, they come with certain strings attached. These are detailed in your plan document and award letter.
The plan document covers topics such as what happens to your options if you retire, leave the company, pass away or become disabled. The plan document also covers when and how your options may be exercised.
Your award letter details the amount of options you have received, the strike price, when these options may be exercised (vesting) and when they expire.
When you receive options, be sure to review these documents and look for the following:
- Key dates such as when the options vest and when they expire.
- What happens to your options under different circumstances such as retirement and leaving the company.
Not paying attention to the current stock price
Changes in stock price can dramatically change the value of your stock options. Big swings in price can move an option grant from being “in the money” (stock price above the exercise price resulting in value for the option if it is exercised) to being “out of the money” or “underwater” (stock price below the exercise price giving the options no value if exercised).
As the stock price changes, employees with a lot of options can see large moves in the overall value of their portfolios. The degree of concentration in Stryker can also fluctuate and reach very high levels. As the stock price moves, your level of risk tied to one company and also tied to stocks in general can change meaningfully. This is important to be aware of as you manage your overall risk.
No overall plan to deal with your options
As you think about what to do with your options, there are a number of considerations that come into play. These can include your outlook for the company, the level of risk in your portfolio at both the company level and asset class level, and the tax impact.
While all of these are important, the first consideration should be what overall financial goals you are looking to achieve. These could be tied to college savings, retirement or purchasing a vacation property, to name a few. By determining your overall goals, you are able to start to develop an overall options strategy to best advance those goals.
Employee stock options present a tremendous opportunity to participate in the success of your company. That said, they leave you with many choices. The right course of action is not always clear. Consider the some of the points highlighted above as you deal with your stock options. If you would like to hear how we have worked with Stryker employees to manage their stock options, schedule a call with us here.