Whether you are a recent hire at a startup or a long-time employee of an existing company, stock options may have been offered to you. Understanding stock options and how they tie into your compensation as an employee is challenging. Here’s what you need to know about investing in your employer’s stock:
What are They?
Stock options are a common tool used by companies to incentivize employees. These options allow the employees to purchase shares of the company’s stocks at a pre-decided price.
Here’s a list of some common terms you may hear when talking about employer stock options:
- Exercise is a term used to describe your right to purchase shares at the grant price.
- Exercise Date refers to the date that you buy shares of company options.
- Grant Price is the price paid if you choose to purchase company shares later.
- Grant Date refers to the date that your employer offers you options.
- Expiration Date refers to the date that your incentive options expire. Options expire 90 days after parting ways with a company and ten years after the grant date if you continue working for the company.
- Vesting Period refers to the period you must wait after the grant date before you can own your options.
- Bargain Element is the difference in the exercise price and the market value of those stocks on the exercise date.
How Do Employee Stock Purchases Impact Retirement?
One question that many people ask when thinking about buying options from their employers is how it affects retirement. Using an ESPP calculator, you can easily find answers to your questions.
After doing so, you can start to think about how diversified your portfolio is, and how your employer’s options fit into the mix.
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Types of Options
There are many different types of stock options that your employer may offer you. Here’s a rundown of the most common types:
Incentive Stock Options (ISOs)
ISOs are statutory options that get better tax treatment than nonstatutory types. You don’t have to add these stock options to your gross income at exercise or grant.
The year that you exercise, you might be subject to the Alternative Minimum Tax (AMT). When you decide to sell shares that were obtained from exercising ISOs, your tax treatment will be decided by the length of time you held those shares.
Employer Stock Purchase Plan
ESSP’s allow employees to buy company shares via payroll deductions at a discount that’s up to 15% below market value.
Payroll deductions add up throughout an offer period, and then the shares can be bought by participating employees.
ESSPs are convenient because you can own shares without needing to complete transactions on your own.
Should I Purchase Company Options?
Stock values can rise and fall over time, so having too much of any one business’s stock may put you at increased risk. In addition, if you’re employed by this same company, your earnings, and your portfolio are potentially both at risk if things turn for the worse.
A smart portfolio is a diversified one because it spreads out risk. Depending on the how much over your overall portfolio your options make up, you might consider selling off some options as you are able, and move those funds into other stocks, to help spread out the risks.