Stock Option Planning

Stock options are an increasingly popular job perk. At some point, employers realized that allowing their employees to own a small slice of the company motivated them to work harder. It makes sense: We care about the things we own. Stock options are also a smart way for start-ups to attract talent without sacrificing much needed cash.

Employee ownership comes in two similar but distinct forms: stock ownership and stock options. An employee stock ownership plan (commonly abbreviated ESOP) is a lot like a 401(k) in that the money put into the plan accumulates and earns interest tax-free until it is withdrawn. Unlike a 401(k), however, the investments are limited to the company’s stock. Assuming the company does well, an ESOP can be a mutually satisfactory arrangement for both employer and employee: a way of sharing the wealth to motivate both sides to work a little bit harder.

A stock option plan allows employees to purchase a set number of the employer’s shares at a specific price at some future date. The specific price is referred to as the “strike price” or “grant price” and the time frame varies by company. By purchasing shares at a low price, the employee has an opportunity to make an excellent return on investment if the company earns a profit and the shares perform well. Most of the time, shares come with a vesting period, meaning they can be converted to stock only after a certain time period has passed. Most of the time, this waiting period is around 4 to 5 years. Many vesting periods follow a staggered schedule, allowing employees to purchase stocks in groups over the course of a series of separate vesting periods.

Stock option plans can be further broken down into non-qualified stock options and incentive stock options. Generally, you must pay income tax on non-qualified stocks when you exercise them – that is, turn your shares into stocks. Income tax is assessed against the difference between present day stock value and the strike price. With incentive stock options, you pay no income tax until you sell the stock.

Buying and selling stock can be a relatively complicated process, especially when it comes to taxes. For this reason, it is important to consult with an experienced financial advisor before taking any action on stocks or options you own through your employment.

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