Sorry, you need to enable JavaScript to visit this website.
Skip to main content

Sunday, November 12, 2023

Guide to employee equity compensation

Equity compensation: An employee guide 

Equity Compensation: An Employee Guide | Empower
Author
11.15.2022

Here’s the main benefit of receiving employee equity compensation: It has the potential to bolster your long-term financial goals.

Yes, potential.

You’ll be reading that word a lot throughout this article. We’ll discuss why.

Given the rise in popularity of equity as a form of employee compensation — and thus, as a potential portion of your wealth — it’s important to know the basics of popular forms of equity compensation.

Equity compensation can be complex. But with the right knowledge and a clear strategy in place, you may be able to leverage your equity compensation within a comprehensive financial plan to meet your goals even sooner than you may have planned.

Let’s dig in.

What is employee equity compensation?

Employee equity compensation is a form of non-cash compensation that gives you partial ownership in your company.

Both startups and established companies offer equity compensation for myriad reasons. One of the more common purposes is to free up cash flow by offering this alternative form of compensation instead of cash. Another driver is attracting high-quality talent — and then keeping those people motivated to both achieve performance goals and remain employed with the company.

Main types of equity compensation

There are generally three types of equity compensation awarded to employees:

  1. Stock options
  2. Employee stock purchase plans
  3. Restricted shares

Each type of compensation has unique characteristics, so it’s important to identify your type of equity compensation so you can understand its benefits and potential challenges.

 

Description

Benefits

Stock options

Employees have the right, but not the obligation, to purchase share of company stock at a predetermined strike price.

If the company’s stock price rises, employees can purchase shares at a discount with their options.

Employee stock purchase plan (ESPP)

Employees can purchase share of company stock on a set schedule through the use of payroll deduction.

Employees can purchase company stock at a discounted price, often with tax advantages.

Restricted shares

Employees receive restricted stock units (RSUs) as a form of compensation.

Restricted shares serve as an additional form of compensation for employees and allow companies to retain key employees.

Stock options

With stock options, employees have the right — but not the obligation — to purchase company stock at a predetermined exercise price. Types of stock compensation options generally can be categorized as either incentive stock options (ISOs) or non-statutory stock options (NSOs), which are sometimes also known as non-qualified stock options (NQOs).

The biggest difference between these two types is their tax treatment. NSOs are taxed as ordinary income when an employee exercises them. If the shares are held for more than one year after exercise, they can be sold at preferential long-term capital gains rates. ISOs are a bit more complex but can have potential tax benefits depending on when they’re exercised and how long the shares are held before sale. Exercising ISOs may or may not cause the alternative minimum tax to apply, but if the shares are held for more than two years after grant and more than one year after exercise, they can be sold at long-term capital gains rates, which are typically lower than ordinary income rates.

Employee stock purchase plans

In an employee stock purchase plan (ESPP), employees can buy company stock, usually at a discount. Employees contribute to the ESPP via payroll deductions. On certain dates, the company will use the funds in the ESPP to purchase shares for the employees, often at a discount of 5% to 15%. If the shares are held more than two years after grant and more than one year after purchase, they can be sold at long-term capital gains rates. That can be a nice tax benefit, but in some cases it can also make sense to just sell shares as soon as possible and capture a guaranteed discount.

Restricted shares

Restricted shares (in the context of equity compensation) are usually structured as either restricted stock units (RSUs) or restricted stock awards (RSAs). Unlike with other types of equity compensation, employees don’t have to buy them — they simply receive the shares as compensation. Companies usually grant RSUs on a vesting schedule that’s tied to either a particular amount of time with the company or certain performance milestones. An employee doesn’t get any tangible value from the shares until they’re vested. When RSUs vest, their value is considered ordinary income.

What’s the value of employee equity?

When considering the true value of employee equity, you are often in a speculative position. Sure, you have the possibility of coming into a windfall like Katie. But keep in mind that you’re also placing a bet on the same company that also signs your paycheck. The biggest risk comes if most of your net worth is tied up in your equity.

Rather than let company stock dominate your portfolio, part of managing your wealth is figuring out how (and when) to:

  1. Sell down some of your shares in a tax-efficient manner.
  2. Build a diversified portfolio appropriate for your risk tolerance and financial goals.

It’s important to understand your awards, vesting schedule, potential tax consequences and concentration risk within your overall allocation. The more information you’re armed with, the better you know what your equity compensation could ultimately be worth — potentially.

RO2477149-1222

JJ Lester, CFP®

JJ Lester, CFP®

Contributor

JJ Lester is a CERTIFIED FINANCIAL PLANNER™ at Empower. Prior to his work at Empower, JJ served both as an estate specialist at Oppenheimer Funds and financial advisor through LPL Financial. JJ holds an M.S. in Management from The American College of Financial Services and a B.A. in Psychology from the University of Colorado, Boulder.

The content contained in this blog post is intended for general informational purposes only and is not meant to constitute legal, tax, accounting or investment advice. You should consult a qualified legal or tax professional regarding your specific situation. No part of this blog, nor the links contained therein is a solicitation or offer to sell securities. Compensation for freelance contributions not to exceed $1,250. Third-party data is obtained from sources believed to be reliable; however, Empower cannot guarantee the accuracy, timeliness, completeness or fitness of this data for any particular purpose. Third-party links are provided solely as a convenience and do not imply an affiliation, endorsement or approval by Empower of the contents on such third-party websites. 

Certain sections of this blog may contain forward-looking statements that are based on our reasonable expectations, estimates, projections and assumptions. Past performance is not a guarantee of future return, nor is it indicative of future performance. Investing involves risk. The value of your investment will fluctuate and you may lose money. 

Certified Financial Planner Board of Standards Inc. (CFP Board) owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER™, CFP® (with plaque design), and CFP® (with flame design) in the U.S., which it authorizes use of by individuals who successfully complete CFP Board's initial and ongoing certification requirements. 

Advisory services are provided for a fee by Empower Advisory Group, LLC (“EAG”). EAG is a registered investment adviser with the Securities and Exchange Commission (“SEC”) and subsidiary of Empower Annuity Insurance Company of America. Registration does not imply a certain level of skill or training.