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5 Essential Steps to Incorporate Equity Compensation Into Your Financial Plan Thumbnail

5 Essential Steps to Incorporate Equity Compensation Into Your Financial Plan

By Trent Derrick, CMT®

Equity compensation is a fantastic perk that boosts employee loyalty and retention rates, all without the immediate costs of salary hikes or retirement plan contributions. No wonder it’s gaining popularity among employers! But for employees, navigating equity compensation can be nuanced and tricky. That’s where we come in.

In this guide, we break down everything you need to know about incorporating equity compensation into your financial plan. Many people aren’t sure how to maximize their equity comp, but our team at Legacy Wealth Management has the experience to help you make sense of the different models and how to optimize them. Ready to dive in? Check out these 5 tips to kick-start your action plan. 

Where Does Equity Comp Fit In?

In practice, we have found there are two main ways you can take advantage of equity compensation: cash flow planning and investment planning. Both options have several specific actions you can take to better utilize your equity benefits.

Cash Flow Planning

Cash flow planning involves budgeting and tracking income and expenses in an effort to better allocate your resources toward savings and other financial goals. For those who receive equity compensation, cash flow planning is key to incorporating your benefits into your overall financial plan.

1. Fund Cash Flow Shortages 

    Over the years, total compensation packages have skewed more and more to the equity side and less to high base salaries. This can create problems for many clients because as salaries remain the same, housing costs, child care costs, and the cost of daily goods and services continue to rise, leaving many clients to rely on their restricted stock vesting and/or bonuses to fill in the gaps. 

    If this sounds like you, consider creating a budget to help identify the monthly or annual shortage between your base salary and your non-discretionary expenses. Once this has been done, you can sell the number of company shares required to cover your shortfall.

    It is important to map this out prior to when you actually need the funds, so you can be sure your actions are tax-efficient. Accurately valuing your stock options or RSUs is also crucial. The last thing you want to do is sell, thinking you will receive a certain amount, only to learn that your net earnings are much lower. This can be especially harmful if the purpose of the sale is to fund everyday living expenses.

    2. Fund Future Goals

    Alternatively, if you do not need to sell the shares to fund your monthly cash flow, you can instead allocate them toward future goals, like large one-time purchases, home renovations, vacations, retirement savings, or education funding.

    Once you have decided on a goal, it can be funded by selling the underlying stocks associated with employee stock purchase plans (ESPPs), employee stock options (ESOs), or vested restricted stock units (RSUs). 

    All these options should be well planned out since holding the stock for at least one year prior to selling will result in favorable tax treatment. It is crucial to incorporate equity compensation into your financial plan sooner rather than later. The tax consequences for these plans are usually years in the making, so you will want to plan far in advance to reduce your liability and maximize your benefits.

    Investment Planning

    While the cash flow planning strategy focuses on selling stock for funds that can be invested, the investment planning strategy focuses on staying invested in your company stock and how that can be used to maximize your future financial goals. 

    3. Evaluate Your Company’s Performance

    The first step you should take when incorporating equity compensation into your financial plan is to evaluate your company’s stock objectively. How is it performing relative to the entire industry’s performance?  How is the industry performing relative to the market?

    It is easy to get swept up in rooting for the home team; after all, they are the ones who pay you. But would you buy your company’s stock if you did not work there? If the answer is no, then you probably do not want to hold onto the stock for much longer than you have to. 

    4. Buy and Hold

    If you evaluated your company’s performance and decided yes, you would buy the stock even if you did not work there, consider using a buy-and-hold strategy. Not only will this give you the potential for growth, but it will also help you minimize tax liability by allowing any gains to be considered long-term. Keep in mind that this strategy should be periodically reevaluated to ensure it continues to make sense in your overall plan. It should not be a set-it-and-forget-it mentality, especially if it leads to an undiversified investment portfolio.

    5. Consider Diversification

    Speaking of diversification, it is important to assess your overall risk level when you own large amounts of company stock. If it makes up more than 10% of your total investable assets, you are in a highly concentrated stock position. This is great if your company stock does nothing but grow for the next 20-plus years, but the reality is that most stocks have dramatic ups and downs that can wreak havoc on a financial plan. 

    In order to mitigate the downside risk associated with concentrated stock positions, there are a number of options to diversify your portfolio you can consider. Consult your financial professional for the specific options available to you.

    Discover Your Equity Compensation Choices

    If stock options or other equity compensation are a significant part of your employee benefits, don’t hesitate to get in touch with us. The fee-only financial advisors at Legacy Wealth Management are dedicated to helping our clients like you fully understand their equity compensation and how it fits into their overall financial planning strategy.

    Let’s chat about how we can assist you in planning for your future. Schedule a free introductory meeting by reaching out to me at trent@legacywm.com.

    About Trent

    Trent Derrick is a financial advisor and Chief Market Technician at Legacy Wealth Management. He is passionate about the value small businesses bring to their communities and specializes in serving small business owners by providing seamless financial advisory services tailored to their financial needs, including tax planning strategies, cash flow management, and retirement planning. Trent obtained his bachelor’s degree from the College of Charleston, studied economics at the University of South Carolina, Columbia, and is a Chartered Market Technician® (CMT®) professional. Outside of the office, he serves as a guest lecturer for the College of Charleston’s MBA program and acts as chairman of the Market Technician Association’s Charleston chapter. To learn more about Trent, connect with him on LinkedIn.

    The opinions voiced in this article are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which strategies or investments may be suitable for you, consult the appropriate qualified professional prior to making a decision. 

    Legacy Wealth Management and LPL Financial do not offer tax advice or services.