If your company grants you a stock award or you’re considering a job that includes equity compensation, make sure you understand the risks and benefits.
If you receive a stock award from an employer, you become a part-owner of the company and can benefit if its share price goes higher. Like any other investment, though, stock awards come with risks. If your company grants you a stock award or you’re considering a job that includes equity compensation, here are a few questions to consider:
What Type of Stock Award Are You Receiving?
Employee stock option plans (ESOPs) and restricted stock units (RSUs) are among the most common types of equity compensation. An employee stock option is a contract that grants you the right to buy shares in your employer’s company at a specific, fixed price, known as the exercise price, after a designated date. An RSU, in contrast, is granted to an employee without any out-of-pocket costs but typically provides limited ownership rights.
There are other types of employee stock awards, including stock appreciation rights (SARs), which allow you to profit from an increase in a company’s stock price without ever having to buy the stock. With SARs, you’ll only benefit if shares rise, and you won’t face losses in the case of a stock price falling. Restrictions are typically involved, including that you remain employed and in good standing.
Employee stock purchase plans (ESPPs) aren’t awards but rather offer the ability to purchase company stock directly at a discounted price. Typically, to be eligible, you need to have been employed by the company for a specific period of time. Some plans allow you to sell your purchased shares at any point, subject to capital gains tax laws; other plans include certain restrictions around timing and quantity of shares sold.
Is Your Stock Award Time-Vested or Performance-Based?
It’s common for executives to receive performance-based equity awards, meaning that their stock options may only be exercised or they only receive full ownership of their RSUs once certain performance goals are met. Performance-based equity awards are more unusual for employees at other levels.
However, companies can use awards that vest over a certain time period as an employee retention incentive. Vesting is contingent on you remaining with the company, with RSUs, SARs and stock options vesting gradually over time. Sometimes vesting doesn’t begin until you’ve been with the company for a year or more. For example, following your one-year anniversary of employment, you might see your stock award vesting on a monthly basis. Sometimes, the timeline can be much longer. Consult your company’s benefits department to learn how your vesting schedule works.
Are You Guarding Against Concentration Risk?
Generally speaking, portfolio diversification is a good way to mitigate investment risk. Having a large portion of your assets in one stock is referred to as concentration risk, and you could find yourself facing steep losses if that stock suddenly underperforms.
If you’re a longtime employee and have accumulated large holdings of your employer’s stock or stock options, talk with an investment professional about whether your overall portfolio is appropriately diversified and whether you should reallocate any of your assets. Evaluate your total holdings, taking into consideration company stock that you’ve accumulated in your 401(k) account as well.
Do You Understand the Tax Implications?
RSUs, SARs and stock options are all subject to taxes, though in different ways. Because taxes and stock awards are complex, consider consulting a tax professional to learn more about the tax implications of your company holdings.
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