Understanding Equity Compensation

When your employer offers you company stock or another form of equity compensation, it can be an exciting opportunity. An ownership stake may allow you to participate in the company’s growth while adding another component to your overall compensation.

But equity compensation can also come with important tax, investment, and retirement considerations. Understanding how these benefits work can help you make more informed decisions about your compensation package.

What Is Equity Compensation?

Equity compensation generally refers to benefits that give employees an ownership interest in their employer. Depending on the company and your position, this could include company stock, stock options, restricted stock, or other equity-based benefits.

In some situations, employees may also have the opportunity to purchase company stock through an employer-sponsored retirement plan, such as a 401(k).

While receiving additional cash may seem like the obvious choice, there are circumstances where holding company stock could offer potential advantages. The right decision depends on your financial situation, investment goals, tax considerations, and the amount of risk you're comfortable taking.

Consider the Tax Implications

Equity held within an employer-sponsored retirement account can have different tax considerations than investments held in a regular brokerage account.

One strategy that may apply in certain circumstances is Net Unrealized Appreciation (NUA). NUA can allow the appreciation of qualifying employer stock held inside a workplace retirement plan to potentially receive long-term capital gains treatment when the stock is eventually sold, rather than having the entire distribution taxed as ordinary income.

However, NUA rules are complex and specific requirements must be met. This strategy generally applies to qualifying employer securities distributed from a workplace retirement plan and isn't available for investments held in other types of accounts.

Potential Benefits of an NUA Strategy

For eligible investors, one potential advantage of NUA treatment is the possibility of having the stock's appreciation taxed at long-term capital gains rates when the shares are sold. Depending on your circumstances, those rates may be lower than ordinary income tax rates.

This could potentially reduce the tax impact associated with distributing highly appreciated employer stock.

However, tax savings shouldn't be the only consideration.

Don't Overlook Investment Risk

Keeping a significant amount of your wealth in one company's stock can create concentration risk. Your income, career, and investments may already be tied to the same employer, so holding a large position in company stock could leave your finances particularly exposed if the company's value declines.

Before deciding how to handle employer stock, consider both the potential tax benefits and the investment risk involved.

Understand Retirement Distribution Rules

Retirement accounts also have rules governing when and how money can be withdrawn.

Under current federal law, required minimum distributions (RMDs) generally begin at age 73 for many retirement account owners, although the rules can vary depending on the type of account and individual circumstances.

Withdrawals from traditional 401(k) plans and other tax-deferred retirement accounts are generally subject to ordinary income tax. Taking certain withdrawals before age 59½ may also result in an additional 10% federal tax penalty unless an exception applies.

Look at the Bigger Picture

Equity compensation can be a valuable part of your overall financial picture, but deciding what to do with it shouldn't happen in isolation.

Your compensation, retirement savings, investment portfolio, tax situation, and long-term financial goals all play a role in determining whether holding, selling, or restructuring company stock makes sense for you.

A financial professional can help you evaluate your options and coordinate your equity compensation with your broader financial strategy. Because tax rules and distribution requirements can be complex, it's also important to consult a qualified tax professional before making decisions that could have significant tax consequences.

Make Your Equity Work as Part of Your Bigger Financial Plan

Your employee benefits can be more than just part of your paycheck. Understanding how equity compensation fits into your overall financial strategy may help you make better-informed decisions today while working toward your long-term goals.

This article is provided for general educational and informational purposes only and should not be considered tax, legal, or investment advice. Tax laws and regulations are subject to change. Individual circumstances vary, and you should consult qualified financial, tax, and legal professionals regarding your specific situation before making financial or tax-related decisions.