Stock options and restricted stock units (RSUs) are becoming a common piece of the total compensation package we see when we work with employees at tech companies and other equity-heavy employers. At Ceva, we’ve found that saving for retirement from a salary and incorporating equity compensation into that same plan call for two different mindsets.
Making automatic contributions to an employer-sponsored plan is the foundation of tax-advantaged retirement savings, and you want to be sure you take full advantage of it. Once you set it up, it happens without you thinking about it. Creating a retirement income plan from stock requires more proactive and consistent attention. In our planning process, we treat it as its own line item, since it may fit into your retirement income picture in a different place than traditional savings.
Depending on where you are in your career, you may have decades to exercise options and build a plan to save consistently. Or you may be close enough to retirement that you’ll need to carefully plan your date to vest as much as possible before your employment ends.
Taking Care of the Basics
Retirement planning starts with consistently putting away as much as you can and getting the most benefit out of what you’re saving. Take the time to understand the contribution limits for your 401(k) plan, whether you get a matching contribution from your employer, and whether your company offers an employee stock purchase plan. These are all worth revisiting annually, so that as your salary increases, your savings contributions grow along with it.
If retirement is some years away and you’re exercising options and selling stock, you should also be saving a portion of the proceeds in an IRA or a taxable account with a long-term time horizon. Depending on whether your company is public, or the expected timeline for going public, a backdoor Roth IRA can also be a good way to create tax-advantaged retirement savings from an equity position. This is exactly the kind of decision we like to walk through within a broader planning process, since the right sequencing depends on your full financial picture, not just the stock.
Addressing Concentrated Stock Positions
If you have stock options and an employee stock purchase plan, you may end up overconcentrated in your company’s stock. Since your employer is also the main source of your income, this can have an outsized impact if anything goes wrong. While a general rule of thumb is to hold only 10-15% of your portfolio in a single stock, the right number is different for everyone and depends on your situation.
You may have built up a large enough retirement balance in your 401(k) and after-tax IRA accounts to meet your needs in retirement. If so, holding a higher concentration of company stock and accepting the volatility may be worth it for the potential upside. If the stock is the bulk of your retirement savings, it’s worth thinking through ways to diversify your portfolio over time.
Decide Where the Equity Compensation Fits into Your Retirement Income Picture
Depending on how many shares you hold and their value, one of the best uses of equity compensation is to help fund an early retirement. If you can realize enough to live on, equity can allow you to retire early and create an income stream without paying the penalty for early withdrawals from a retirement plan. It can also help you delay Social Security to maximize your annual benefit.
Using stock as your primary source of income can be tax efficient when it’s planned for. Exercising your options and selling your stock can result in taxation as both earned income and capital gains, and you can be subject to the alternative minimum tax. Having a lower income in the years you are selling stock can result in lower taxes overall, which is the kind of tax-aware sequencing we build into a client’s broader plan rather than deciding year to year.
Getting Close to Retirement
As retirement gets closer, assessing the value of your shares becomes important to understanding your total retirement income picture. Your vesting schedule will spell out your rights to the stock award. You will likely have both vested and unvested shares, and once you retire, you may forfeit any unvested shares. Depending on the value of those shares, you may want to delay your retirement past key vesting dates.
Once your employment is officially terminated at retirement, something called the “post-termination exercise clock” starts counting down. A common provision allows 90 days post-termination to exercise vested employee stock options, so timing matters more than it might seem.
Weighing Taxes and Price Volatility
If you plan to use your equity compensation to fund an early retirement, you’ll need to sell your shares at some point. Taxes will be due, and you’ll want a plan for when you sell so you can minimize taxes and take advantage of lower income years in retirement. You’ll still be exposed to the price volatility of the stock in the meantime. Creating a plan that produces income, reduces volatility, and avoids a big unplanned tax bill takes careful, ongoing planning, not a one-time decision.
The Bottom Line
Equity compensation is increasingly common and can add significantly to your personal wealth. It can represent the risk you take and the commitment you make when joining a company, and it can result in larger payoffs than traditional compensation alone. That said, it’s also riskier and more complicated than traditional retirement savings. Our approach at Ceva is to help you maximize both pieces, salary-based savings and equity, so they work together toward retiring on your own schedule and funding the life you want afterward.
Reach out to our team if you’d like to discuss how this applies to your situation.
This article is produced by Ceva Capital dba Ceva Advisors. The information contained in this report is informational and intended solely to provide educational content to our clients and other readers that we find relevant and interesting. Opinions expressed are just that, and are current only as of the date of publication. Nothing in this document should be construed as investment, tax, or legal advice; we provide advice on an individualized basis only after understanding your circumstances and needs. Information provided comes from sources we believe are reliable, but accuracy is not guaranteed.
