As your retirement date gets closer, it’s important to remain proactive about your financial plan. A retirement plan can help you understand what assets you have available for retirement, where your income will come from, what expenses you may incur, and how all the pieces of your plan fit together to ensure you can successfully transition to the retirement you want.
As part of this retirement planning process, you may want to pay particular attention to your equity compensation package if you have acquired a meaningful position in company stock during your tenure.
Participating in an equity package at your company may have helped accumulate the wealth you needed to reach your retirement goals – but going from employee to retiree may change your thinking about the amount of company stock you continue to hold.
To determine whether or not you need to change how you manage your equity compensation as you near retirement, you’ll want to compare your existing investment risk profile to your target retirement risk profile. You’ll also want to consider how dependent your retirement plan is on the value of your company stock and how you’ll feel about the stock when you are no longer an employee. And finally, you should plan for what happens to your equity compensation when you retire so you can be properly prepared.
This evaluation may help you determine how much company stock you want to hold and, if changes need to be made, what a reallocation might look like.
Equity Compensation Can Lead to a Concentrated Stock Position
You might start by determining how much of your liquid net worth is invested in a single stock position. While this is a good idea for all retirees, it may be even more important if you have equity compensation.
If you have several types of equity compensation, you can broadly determine how much of your liquid net worth is invested in a single stock position by dividing the value of shares you own outright, and the value of vested but unexercised stock options, by your total liquid net worth.
(“Value of Shares Owned” + “Value of Vested but Unexercised”) / “Liquid Net Worth”
Some financial planners suggest keeping no more than 10-15% of your investable net worth invested in a single stock, although this is a rule of thumb and your specific situation may mean its suitable to hold more or less than this range. If you exceed this benchmark, it may lead to concentration risk, or the risk that you are not diversified and too much of your wealth is tied to the fate of one security.
As you approach retirement, the potential volatility of a concentrated single stock position may be more than what you are willing to assume. If so, then other investment strategies might be more suitable. As you plan for retirement, a good step might be to assess the investment risk that you are willing to take.
Beyond considering the investment risks involved, you can consider how you may feel about owning company stock as a non-employee once you retire. As you move into retirement and no longer work in the day-to-day business of your old employer, your want to retain or sell shares may change from how you felt when you were a more involved employee.
Answering how much company stock you’ll want to own in retirement is a balance between the investment risk that is appropriate for you as you retire as well as how you feel about company stock once you’re no longer working at the company (amongst other things).
These decisions can help you build a plan for what your stock ownership going in the years prior to retirement including how many shares to sell, how quickly to sell them, what the tax implications of this action may be, and what type of equity compensation you may want to act upon.
How Important Is Your Equity Compensation to Your Retirement Plan?
In addition to exploring the percentage of your net worth that is allocated to a single stock, it’s important to consider other non-company stock assets that you have available, as well as sources of retirement income, to fund the retirement you want.
A look at your retirement income and non-company assets can help you understand whether your retirement plan does or doesn’t rely on the value of your company stock. The answer to this may affect how you manage your equity compensation plan going forward.
As an example, let’s say you need $1,000,000 to fund your dream retirement. Let’s also assume that you have the $1,000,000 worth of assets you need — and $500,000, or 50%, of the total, is invested in your employer’s stock.
This is money that is necessary and critical to funding the retirement you want, which suggests having 50% of your retirement nest egg in a single stock is likely a risky strategy.
If you have $2,000,000 in liquid net worth and $1,000,000 is tied up in company stock, 50% of your net worth is still reliant on the positive performance of a single position — but if you only need $1,000,000 to have the retirement you want, then this allocation may be considered less risky as it pertains to the potential success of your retirement plan.
You could look at the company stock as “extra” value above and beyond your need, and depending on your risk tolerance, you may accept the higher potential to realize a lot of loss in the concentration position should things not go so well for the company.
Tactical Planning for Equity Compensation as Part of a Retirement Plan
As you plan for your retirement and determine how much you want to invest in company stock, you’ll also want to consider what may happen with your equity compensation when you retire. It’s possible that you’ll need to plan for the forfeiture of unvested options or shares, timely planning subject to post-termination exercise periods, and other variables
Here are a few things that you may need to think through:
How to Think About Unvested Shares
When you are awarded an equity compensation grant, it is often issued with a vesting schedule that details when and how you gain the right to the award. A vesting schedule is usually based on a set period of time but can also be based on other metrics such as stock prices or EBITDA.
When you retire, you may have both vested and unvested shares. You generally have the right to exercise vested shares so long as you meet the other requirements of your plan document. As you plan for retirement, you can likely count the value of vested shares toward the total value of your retirement assets.
Unvested options and unvested restricted stock may have “value” on paper, but unvested equity may be forfeited if and when you retire. Therefore, it may not be a good idea to include the assumed value of unvested shares or stock in your retirement plan.
You should, however, consider what the value of your forfeited shares may be and how this will impact your retirement. This could be a reason to make small adjustments so that your retirement date is after any key vesting dates, which would give you the opportunity to realize more potential value from your equity compensation.
Planning for Post-Termination Exercise Periods
When you retire from your company and your employment is officially terminated, the post-termination exercise clock starts ticking on your ability to exercise your vested employee stock options.
While you want to check your plan document to get specific details on how your equity compensation works, it’s fairly common to see provisions that give you 90 days post-termination to exercise.
If the expiration date of the stock option is before the end of your post-termination exercise period, you’ll want to exercise prior to expiration. If you miss this post-termination window, the option may be forfeited and you risk losing the value of the option itself.
If you have incentive stock options, you’ll want to pay particular attention to your exercise window. Even if your plan document allows for an extended-term beyond the 90 days to exercise your vested options, ISOs are required to be exercised within 90 days in order to keep their potentially preferential tax treatment.
As you approach retirement, you’ll want to understand how the post-termination exercise of options works in your equity compensation package not just to avoid losing your options, but also because exercising your stock options is a reportable tax event that may impact cash flow and your after-tax value.
If you have non-qualified stock options, the spread between the grant price (or strike price) and the fair market value at exercise is taxed as ordinary income. If you have incentive stock options, the tax impact may be complicated by whether you exercise and hold the shares, or exercise and sell them.
Your retirement planning should include an analysis of what you plan to do during the post-termination window and how these decisions may impact your tax bill, your cash flow, and the amount of proceeds you’ll have available to fund your retirement.
How Will Income Tax Impact Your Equity Compensation Package?
With all equity compensation, income tax is an important consideration both before and after retirement.
The value of your equity compensation could change when you sell your shares. If you have a built-in profit, it’s possible that some portion of the proceeds will go to paying a tax bill. The larger the potential tax bill, the less after-tax proceeds that you’ll have to fund your retirement.
You might be able to plan the tax impact of an exercise, hold, and sell by integrating those decisions with how your adjusted gross income may change in retirement.
If your income will drop after you retire (which is often a reasonable assumption, considering you’re no longer earning the same paycheck from the job you just retired from), you might want to intentionally wait to sell some shares in a lower-income retirement year, transitioning income from what would be a “higher” taxable income rate to a “lower” one. Keep in mind, however, that during this holding period the stock price may fluctuate.
If you have incentive stock options, you may want to consider how the alternative minimum tax may fit into the plan if you exercise and hold shares or exercise and sell them. If you have carry-forward AMT credits from previous years, a good retirement plan will include a plan to get that back as soon as you can.
Equity Compensation in Retirement
Equity compensation as part of a retirement plan can be complicated by investment risk, income tax, financial planning goals, and other factors. As you approach your retirement, you should consider how these factors compliment one another and how they can integrate into a sound financial plan.
You may also want to consider how you’ll feel about owning stock now that you are no longer an employee of the company. Retaining the investment risk of a single stock position may be suitable as you accumulate wealth in your 30’s and 40’s, but that need to accumulate may change in your 50s and 60s.
Ultimately, this transition is often a process that takes you through goal setting, strategic planning, and tactical implementation over a short or long time to help you reach your goals.
The content herein is for illustrative purposes only and does not attempt to predict actual results of any particular investment. All investments are subject to risk, including the risk of principal loss. Diversification does not guarantee a profit or protect against a loss. None of the information in this document should be considered as tax advice. You should consult your tax advisor for information concerning your individual situation. Tax services are not offered through, or supervised by, The Lincoln Investment Companies.
The information in these articles may change at any time and without notice. Laws of a specific state or laws relevant to a specific situation may affect the applicability, accuracy, or completeness of this information. The information presented here is not specific to any individual’s personal circumstances. There is no guarantee that any strategies discussed will result in a positive outcome. The purchase of certain securities may be required to effect some of the strategies.
You should discuss any legal, tax or financial matters with the appropriate professional. Nothing contained herein should be construed as a recommendation to buy or sell any securities. As with all investments, past performance is no guarantee of future results.