Forms of compensation like restricted stock units and performance shares offer advantages over employee stock options. Restricted stock units and performance shares are simpler and have less complex tax implications. However, employee stock options can still be a valuable source of wealth for many households.
Employee stock options grant employees the right to buy company stock at a set price in the future. For example, if an employee received 100 shares at a strike price of $10 per share and the stock price later rose to $20 per share, they could exercise the options and profit from the difference.
There are two main types of employee stock options: nonqualified stock options (NSOs) and incentive stock options (ISOs). NSOs are taxed at the ordinary income tax rate upon exercise, while ISOs offer tax benefits for holding the stock after exercise to qualify for lower capital gains taxes.
Employees with significant stock options face the risk of having too much of their wealth tied to their company's performance. Diversification is key, and employees should consider selling shares gradually to manage risk and tax implications.
One strategy to mitigate risk is to exercise options in portions over time, similar to dollar-cost averaging. This approach helps spread out tax costs and minimizes the impact of market fluctuations on the timing of exercises.
Seeking advice from a tax or financial advisor familiar with stock options can help employees make informed decisions about when and how to exercise their options.
For more personal finance content, visit Morningstar's website.
