|
BUSINESSWEEK ONLINE: DAILY BRIEFING | |||||||||||
| |||||||||||
|
| |||||||||||
What to Do with All Those Stock Options? Believe it or not, you can rack up headaches as fast as paper profits 
People who got in on the ground floor of fast-growth startup companies, especially in high tech, often have a problem many plodders in the corporate world would gladly take on: Their stock options can be worth so much money that they don't know how to handle them. Microsoft millionaires were the early notables, but they're now joined by legions of entrepreneurs and employees who, thanks to huge runups in their company's stock, have paper profits in the six or seven digits. "Of course, it is a great benefit," says Lewis J. Altfest, a New York financial planner. "But with the bull market that we've had, it's turning into an enormous problem for some people in terms of knowing what to do."
Among the issues options holders have to grapple with are timing their stock sales and the taxes they'll incur. And even if you have a year or more to wait before your options vest, it's best to think now about what your choices will be and what your goals are. Indeed, timing your options moves can be a treacherous exercise. One danger, of course, is that your windfall may evaporate by time you're ready to exercise your options and sell. For instance, even with the Dow making new records almost every day lately, some of the highest-priced technology stocks, especially the Internet names, have stumbled in recent weeks. And the market seems to be rotating in favor of old-line industrial companies and cyclical names. FIRST-DAY RUSH. Another quirk of timing when it comes to IPOs is how soon after the offering you should exercise and sell. If you hold stock options from one of the dozens of Internet companies that are planning on going public soon -- and at least some of those options have vested -- your best chance to cash in could be during the first day of trading, since many IPOs quadruple on opening day and then slide in price. Also, many investment pros believe Internet stocks are in a "bubble" that will eventually pop -- and that the surviving companies won't trade this high again for years. Just as millions can be made overnight in options, paper profits can disappear quickly if the market starts to slide. These market conditions have reversed the conventional wisdom on how to manage stock options. Instead of advising employees to hold onto their company stock as long as possible (in order to take advantage of future gains as well as tax benefits), some investment advisers are telling clients they would be better off cashing in their options first chance they get. "For a lot of people, they should just take the money off the table," says Joel Isaacson, a New York City financial planner. In general, investment advisers say you shouldn't have more than 40% to 50% of your net worth tied up in your company. "But it depends on how wealthy you are," says Isaacson. For a 30-year-old with only $10,000 in savings, $10,000 in a 401(k), and $2 million in stock options, "I would be more anxious to take some off the table," he says. NEED CASH NOW. Even if you think your company has tremendous future prospects, it could be wise to diversify your assets. "People in general tend to be too optimistic about their companies," says Altfest. And even though your company may continue to excel against its competition, its stock could still be brought down by a broad market decline. Plus, points out Isaacson, most employees get more options each year, so if they sell some now, they can always rack up more next year. In fact, most people do cash in their options as soon as they vest, usually after three to five years at the company. "At least two-thirds of people are going to exercise shares and sell because they need the money," says Corey Rosen, director of The National Center for Employee Ownership. Exercising options and selling company stock is further complicated by tax concerns, many of which are avoidable. First, the two different types of stock options get different tax treatments. Nonqualified options (NSOs) generally go to the broadest group of employees. With NSOs, you must pay income tax (which is 40% at the highest bracket on the federal level) on the spread between your "strike price" (the price of the stock when the options were issued) and the market price when you exercise them even if you don't sell the shares until later. If your strike price is $8 and you exercise at $80, you'll owe income tax on the $72 gain per share that year. If you hold the shares for five more years and the stock climbs to $150, you can pay the 20% capital gains rate on the additional $70 gain. If you plan to hold the company stock, with NSOs, there's actually an incentive to exercise your options when the stock is at a temporary low to minimize the immediate income tax bite. Incentive stock options (ISO), which have some tax benefits, usually go to top execs. These options aren't taxed until you sell the shares, and as long as you hold them a year, you can pay the lower capital-gains rate (20%) on the spread between the strike price and the market price at the date of sale. In this case, using the above example, after five years you would owe capital gains tax on $142 ($150 share price minus your $8 strike price) for each ISO share. The exception is if you trigger the dreaded alternative-minimum tax. That separate tax structure, designed to make sure rich folks pay their share of taxes, can kick in when taxpayers have low income and high capital gains. TOUGH CALL. In most cases, you should hold the company stock, once you've exercised your ISOs, for at least one year to get the favorable capital-gains treatment. But given how volatile tech stocks are right now, it may be worth paying the higher income tax rate to lock in gains now, says Isaacson. For example, if you exercise an ISO trading at $100 now and sold the share immediately, you would get roughly $60 in cash. If you wait a year and the price stays the same, you would net $80 in cash. But if the stock fell to $75 in a year, you would net $60 a share. "You need to make a judgment," says Isaacson. "Is this a stock that could just as easily be $75 in a year?" If it is, you might want to sell immediately. Jane King, with Fairfield Financial Advisers in Wellesley, Mass., says she comes up with a five-year options plan for clients. Along with doing some tax planning, one goal is to make sure they aren't planning on cashing in a large chunk of company stock at a specific point, say for a child's college education, forgetting the risk that the stock could be in a temporary trough at that point -- not the time you'd want to sell. Employees may also be forced to exercise their options at an inopportune time in the market if they leave the company. Most options plans require that you exercise your options within 60 days of leaving the company. Of course, you may not be able to sell enough of your options to diversify properly right away. In addition to the varying lengths of time that options typically vest, corporate insiders may only be able to sell in certain windows, and at some companies, management frowns if you sell. Altfest suggests some employees may be able to use hedging strategies, such as buying put options in their company's stock that will rise in value if the shares go down. But insiders aren't allowed to, and it may not be smart politically to try such maneuvers, says Isaacson. For a hypothetical young woman who just made a killing on stock options at her Internet company but has few other assets, Isaacson says he would first recommend she move some assets to bonds. Then he would suggest she diversify into large, blue-chip stocks. Since her remaining options already expose her to risks of small companies, he would recommend she avoid small-cap stocks. "And," he says, "definitely no more Internet stocks." Stone is an associate editor at Business Week Online
_ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ |
 | |
 | |
RELATED ITEMS
from Business Week frontier When an Internet Company Goes Public, Will its Stock Price Dictate its Strategy? A Cold Look at Going Public A Weak Stock Price Hurts More than Your Ego Living with IPO Regrets  Assistive Technology barker.online Byte of the Apple Eye on Japan Hers.online Inside Wall Street Not-So-Neutral Corner Online Asia Power Lunch Privacy Matters Sector Scope Sound Money Street Wise Washington Watch News Flash Archive | ||||||
