You have many choices to make when you leave your job and head toward the next best thing. Whether you’ve chosen to transition yourself or unforeseen circumstances have made the decision for you, it’s crucial to understand what type of equity or stock-based compensation you have, what to do with it, and how much time you have to act.
Stock-based compensation has the potential to help you achieve greater savings and wealth accumulation over time, but there are risks and considerable tax implications should you leave the company before your shares are vested and exercised. You’ll need to proceed quickly and thoughtfully, so it’s imperative to know what’s outlined in your compensation and grant agreements.
Whether you’ve already acted on vested options or are considering doing so after leaving, the impact is significant. In this article, we take a look at the three most common types of stock-based compensation, the difference between vested and unvested stock options, and why the 90-day post-termination exercise period (PTEP) is of critical importance if you want to safeguard your assets. We’ll also discuss the different tax treatments and potential tax implications so you can make smart decisions quickly.
How To Handle Stock Compensation After Leaving A Company
What is stock-based compensation?
Stock-based compensation (or equity compensation) is a financial perk in addition to your traditional cash-based salary that could make up a considerable portion of your total compensation.
The three main types of equity compensation are employee stock options, RSUs, and employee stock purchase plans. It’s important to note that these are not shares in the company but options to purchase shares at a later date.
What happens to my stock options when I leave a company?
Unvested shares are forfeited.
Vested shares that have been exercised are yours to keep.
You may exercise remaining vested shares within a 90-day window called a post-termination exercise period (PTEP). You’ll need to know your strike price and how many shares you want to purchase to make sure you have the cash to cover the shares.
What do I need to know about taxes?
Nonqualified stock options (NSOs) are likely to incur income tax, while incentive stock options (ISOs) do not.
ISOs not exercised within the PTEP window may be subject to a greater tax liability.
What Is Stock-Based Compensation: Three Main Types
To attract and retain talented individuals, many companies offer stock-based compensation (or equity compensation) in addition to your traditional cash-based salary. Depending on the industry you’re in, stock-based compensation can represent a significant portion of your total income.
Tech companies, particularly startups, are known for offering company equity to attract and keep fresh new talent. The downside is that less of your total income will come to you in your regular paycheck, and your long-term earning potential is tied in large part to the success of the company.
Stock-based compensation can be offered in a number of forms, but we’ll take a look at the three most common types:
- Employee Stock Options (ESOs): ESOs represent the right to purchase shares at a set price called a strike price. The two primary types of ESOs are non-qualified stock options (NSOs) and incentive stock options (ISOs). ISOs, designed exclusively for employees, come with special tax advantages. On the flip side, NSOs require you to pay income tax based on the grant price minus the price of the exercised option.
- Restricted Stock Units (RSUs): RSUs are not stock, rather your company’s commitment to issue shares after a period of time during which specific conditions are met. While this arrangement provides certain advantages to the company, it’s essential to note that you won’t gain any rights of stock ownership, such as voting rights, until the shares are earned and issued.
- Employee Stock Purchase Plan (ESPP): An ESPP allows you to purchase company stock at a discounted rate. Your company will deduct funds from each paycheck from the offer date up to the purchase date, at which time the balance of those funds will be used to purchase stock for you.
Vested vs. Unvested: What Happens To Stock Options When You Leave Your Company?
Unvested Stock Options
- Unvested stock options are forfeited upon separation from the company, making them worthless. Though unlikely, exceptions do occur, so be sure to read your grant agreement thoroughly.
Vested Stock Options
- If you’ve been granted stock options and exercised some or all of them before leaving, those shares are yours regardless of why you’ve left the company.
- However, be sure to check your grant agreement for a clawback clause. If a clawback exists, your company may have the option to separate you from your shares by buying them back.
- If you exercised options early, before vesting, your company can choose to repurchase any exercised-but-unvested shares upon your departure.
RSUs and ESPP Shares
- Unvested RSUs and ESPP shares are lost when you leave.
- Vested shares from RSUs and ESPP shares are yours to keep. If you have a significant portion of your portfolio tied up in your former company’s shares, it’s important to consider diversifying to avoid concentration risk.
How Long Do You Have To Exercise Your Remaining Vested Options?
To avoid the risk of forfeiting your vested options, you must decide quickly whether to exercise them and act on that decision immediately.
You have a narrow 90-day window to exercise any remaining vested options. This is known as the post-termination exercise period (PTEP) and it begins the day your service to the company ends. The company you are leaving isn’t responsible for reminding you about such deadlines, so amid all the moving parts of your transition, it’s important that you are proactive in your planning.
While the 90-day window is typical, variations exist based on your equity plan and specific company’s policies. ISOs, in particular, have specific tax implications tied to the 90-day exercise requirement. Negotiating an extension of your PTEP during exit discussions is a viable strategy, especially if your company allows such flexibility.
How To Exercise Stock Options After Leaving
First, check your grant agreement for your strike price and the payment method required to buy your vested shares. To ensure that you have the cash on hand to cover the cost of exercising your options, take your strike price and multiply it by the number of options you want to purchase.
Timeliness is absolutely key if you want to exercise your remaining vested options before the PTEP deadline. It’s also important to note that you may have to issue an actual paper check before your 90-day exercise window closes.
Tax Implications
Tax treatment differs between non-qualified stock options (NSOs) and incentive stock options (ISOs).
- NSOs often incur income tax based on the difference between the grant price and the price of the exercised option.
- Among other advantages, ISOs do not trigger ordinary income tax on the difference.
- In order for your ISOs to maintain their favorable tax status, you must exercise them before the 90-day PTEP deadline. Otherwise, they may be reclassified as NSOs potentially resulting in higher tax liabilities
We strongly recommend seeking professional advice and a thorough review of your stock option plan in order to make informed decisions for your best interest.
The Bottom Line
When you leave a company with stock options, whether vested or unvested, the implications are substantial. Vested options are yours to keep, but unvested ones often face forfeiture. Deciding how to approach post-employment stock options can be quite challenging. Timely, well-informed decisions are essential to making what you’ve earned continue to work for you. It’s important to understand the specifics of your stock option documents as they are reliable sources that ultimately determine your contractual rights.
Final Thoughts
Regardless of why you leave a company, dealing with your stock options after you go can be complex and dizzying. During this transition we highly recommend seeking professional advice to safeguard your portfolio and set you toward meeting your financial goals
At SK Wealth, our financial planners are all about helping you make informed choices regarding your stock-based compensation and how to plan for your financial future. Over the past 25 years, we’ve honed our financial planning process, The Integrated Financial Advantage™, to offer you our personalized recommendations that empower you to live life with intention, tomorrow and today.
