Vesting Events: What You Should Know

If you receive compensation in the form of company equity awards, such as restricted stock, performance shares or stock options, you have most likely experienced what’s known as a “vesting event”—or will in the future. This is when the equity you receive from your company is transferred to your ownership, usually over a predetermined timeframe.

While your company’s vesting schedule will determine that timeline, what happens next in terms of financial decisions depends on you and your goals. Remember that equity compensation can play a key role in helping you achieve those financial goals—whether you want cash now, plan to hold your stock based on your commitment to your company and the growth you’d like to see, or are wrestling with complex wealth management needs.

In thinking through the choices, it’s important to understand key steps to help prepare for a vesting event, as well as the risks associated with certain choices you might make once your awards vest and their tax implications. 

Plan For Vesting

These four simple steps can help you prepare for a vesting event:

1)   Understand your awards: Get familiar with the type of equity you’ll receive and how your plan is structured, then brainstorm how this can fit into your broader financial plan.

2)   Confirm key dates: Your vesting schedule might release shares to you monthly, quarterly, annually, over a certain span of years or on a specified date, or as a lump sum all at once. Know when your awards are granted, when they vest and when they generate a taxable event.

3)   Build your team: Connect with a Financial Advisor and a tax professional to develop a personalized strategy to manage your vesting awards and incorporate them into your financial planning.

4)   Plan ahead: Decide ahead of time what you’ll do with your vesting awards. 

For example, if you have “restricted stock” awards (i.e., company stock that cannot be fully transferred to you until certain conditions have been met), once a vesting event occurs, you may choose to move the shares into your brokerage account and convert them into cash. Or, perhaps you hold vested call options, which confer the right (but not an obligation) to purchase a certain number of shares at a predetermined price; if the stock is trading above that price, the options are considered “in the money.” In such cases, you may choose to exercise the options for either cash or shares.

Consider the Risks

A key consideration when deciding whether to hold your shares or sell them is how much of your overall financial health and tax liability will be tied up in one company. This is called single-stock risk (or “concentration risk”), where your position in your company stock can be overweight relative to the other assets you hold in your portfolio.

While there are circumstances in which such concentrated holdings may generate substantial wealth for you over time, there are also circumstances in which they can leave you with outsized losses in your portfolio. In addition, even if the stock ends up performing well, that may make it more difficult to manage your portfolio or access the funds later, given that any sales may trigger large income tax liabilities, based on the difference between the price at which you first acquired the shares and the price at which you sell them.

The most important actions to take before and after vesting will depend largely on your personal financial situation, and many of your choices will hinge upon the type of equity award you receive.

Know the Tax Implications

When taking action on your shares, waiting for potential long-term capital gains, versus making short-term sales, can have significant tax-liability implications. For example, if you hold shares longer than one year, any gains upon selling those shares will be taxed as a preferential long-term capital gain. However, if you hold those same shares for one year or less, potentially higher ordinary income-tax rates may apply upon selling.

Additionally, taking action on shares in a vesting event can make it necessary to come up with cash or determine how to cover a large future tax bill. You may also want to strategize how to help minimize, defer and/or delay the potential tax impact.

Additionally, if your employer offers this option, you may consider an 83(b) election, which can accelerate taxes but may provide a tax advantage. For example, if your grant has a fair market value (FMV) and you make an 83(b) election, you would pay tax when the shares are granted. However, this event creates cost basis, which can be used in the future to measure capital gains. Given the complexities involved, it may make sense to consult with a tax advisor about your specific situation.

Also note: Your tax obligations and timetable will largely depend on your company’s plan and the type of equity you receive. For example:

• When restricted stock vests, the value of your restricted shares is usually taxed as ordinary income, with some of the income tax due withheld.

 

• For stock options, vesting is not a taxable event, but exercise is. At vesting, you can decide to hold your stock options unexercised (not taxable); exercise the options and hold the purchased shares (taxable); or exercise the options and sell the shares (taxable). 

 

Consider Working With an Advisor

All told, there’s a lot to pay attention to, so it’s worth taking the time to make sure you’re comfortable with the basics.

If you have questions regarding your tax situation, be sure to reach out to a tax advisor who can help you explore your tax liability and any strategies to help maximize the impact of your equity compensation.

Remember, there’s no one-size-fits-all formula when it comes to equity compensation. Working with a team, such as a Financial Advisor and a professional tax planner, can help you see the big picture and figure out the right approach for you.