Planning for Retirement with Stock Options and RSUs: A Comprehensive Guide

Planning for Retirement with Stock Options and RSUs

Planning for Retirement with Stock Options and RSUs can be complex and overwhelming. Retirement planning is a crucial aspect of your financial independence. And for individuals fortunate enough to have stock options and Restricted Stock Units (RSUs) as part of their compensation package, these assets can play a significant role in securing a comfortable retirement. This article will delve into stock options and RSUs, discussing Incentive Stock Options (ISOs), Non-Qualified Stock Options (NQSOs), RSUs, and Restricted Stock. We’ll explore how these assets can be integrated into your retirement plan while considering various tax implications, concentrated risk, and the importance of a comprehensive financial view.

Understanding Stock Options and RSUs

Incentive Stock Options (ISOs)

Incentive Stock Options, or ISOs, are a type of stock option usually granted to employees as an incentive. They come with tax advantages but also have specific requirements. ISOs allow employees to purchase company stock at a predetermined price, known as the exercise or strike price. To qualify for favorable tax treatment, ISOs must be held for at least two years from the date of grant and one year from the date of exercise. Gains from ISOs are typically taxed at the more favorable long-term capital gains rate.

  • Favorable tax treatment
  • Long-term capital gain tax is 15% or 20% versus your tax bracket
  • Maximum $100,000 of underlying stock value per year
  • No federal and state income tax at the time of exercise
  • If held at least two years from the grant date and one year from the exercise date, you will pay long-term capital gains
  • You may owe Alternative Minimum Tax (AMT) on your bargain element
  • AMT is due every quarter
  • ISOs must expire after ten years
  • ISOs are not transferrable.
  • Disqualifying disposition if you sell shares before the 2-year / 1-year period.
  • Eligible for 83b election

Non-Qualified Stock Options (NSOs)

Non-Qualified Stock Options, or NSOs, are another type of employee stock options.  NOSs are more flexible but have less favorable tax treatment than ISOs. Employees can purchase company stock at the exercise price. NSOs are generally taxable as ordinary income at the time of exercise.

  • Less favorable tax treatment
  • The exercise of NSO is a taxable event.
  • All Federal, payroll, and state income taxes are due on the difference between the Fair Market Value (FMV) of your options and exercise cost
  • FMV at exercise will be the cost basis of your shares
  • Long-term capital gains or losses if you hold your shares for more than one year
  • Short-term capital gains or losses if you hold your shares for less than one year
  • Early exercise when you sell your shares immediately after exercise
  • Eligible for 83b election

Restricted Stock Units (RSUs)

RSUs are a form of equity compensation where employees receive a specified number of company shares at a predetermined future date, usually contingent on meeting certain conditions like time-based vesting or performance goals. When RSUs vest, the value of the shares is typically reported as ordinary income and subject to taxation.

  • RSUs are equity grants with a 4-year vesting schedule
  • The entire value of your vested shares is taxable as ordinary income
  • Taxes are withheld at the time of vesting.
  • The default 22% Federal and 10.23% California withholdings
  • Public companies usually sell a portion of your vested shares to cover taxes.
  • You may need to sell additional shares to pay your full tax amount.
  • Long-term capital gains or losses if you hold your shares for more than one year
  • Short-term capital gains or losses if you hold your shares for less than one year
  • Some startups have a dual trigger vesting schedule. Taxes are due at the time of IPO or exit.
  • Not eligible for 83b election

Restricted Stock Awards

Restricted Stock Awards (RSAs) are similar to RSUs, but employees receive actual company shares at the time of grant, which are typically subject to certain restrictions. These restrictions often involve a vesting period or performance targets. When these restrictions are lifted, the value of the shares is usually subject to taxation.

  • RSAs are typically issued to early-stage employees and founders when FMV is very low.
  • Employees pay for their RSAs at a pre-determined price.
  • The difference between the current FMV and the original purchase price is taxable as ordinary income.
  • Long-term capital gains or losses if you hold your shares for more than one year
  • Short-term capital gains or losses if you hold your shares for less than one year
  • Eligible for 83b election

Employee Stock Purchase Plan

An Employee Stock Purchase Plan (ESPP) is a company-sponsored program that allows eligible employees to purchase shares of their employer’s stock at a discounted price. ESPPs are a popular form of employee benefits. They are designed to enable employees to become partial owners of their company while offering potential financial benefits.

  • $25,000 annual limit
  • You purchase the shares at a 15% discount from the market price
  • Lookback feature allows you to buy shares at a lower price between the beginning and end of the period.
  • Shares are not taxable until you sell them
  • You must hold the shares for two years after offering and one year after purchase
  • The discount is taxable as ordinary income
  • You pay long-term capital gains on the difference between the sale and market prices on the acquisition date.

Incorporating Stock Options and RSUs into Retirement Planning

 Understand what you own

First and foremost, before starting to plan for retirement, you must fully understand what type of equity compensation you have.  There are many rules and restrictions concerning stock options and RSUs. Make sure that you follow the rules and use them to your advantage to maximize your financial outcome.

Know your goals

Knowing your financial goals is a critical foundation for effective financial planning. Your goals will serve as your roadmap, guiding your financial decisions and helping you prioritize where you allocate your resources. Whether saving for retirement, buying a new home, funding your children’s education, or making charitable contributions, having clear, well-defined financial objectives allows you to set specific targets and create a strategic plan to reach them. Understanding your financial goals provides motivation, focus, and a sense of purpose in managing your money, ultimately paving the way to financial security and realizing your dreams.

Assess Your Comprehensive Financial Picture

Retirement planning isn’t just about stock options and RSUs. It’s essential to assess your entire financial situation. This includes other assets, liabilities, savings, and expenses. Creating a comprehensive financial plan that integrates all aspects of your financial life, including your stock-based compensation, can help you decide when and how to retire.

Diversification to Manage Concentrated Risk

Stock options and RSUs can lead to concentrated holdings in your employer’s stock. While it’s a sign of confidence in your company, it can also expose your retirement savings to significant risk if your company faces financial difficulties. Diversification is key. As you approach retirement, consider gradually reducing your exposure to your employer’s stock and reallocating your investments into a diversified portfolio to mitigate risk.

Tax Planning

Effective tax planning is crucial when dealing with stock options and RSUs. Depending on the type of assets you hold, you should exercise them or sell them strategically to optimize tax consequences. This often involves balancing the timing of exercising options and selling shares with your overall financial situation and tax bracket.

Seek Professional Guidance

Stock options and RSUs can be valuable assets in your retirement planning strategy. By understanding the different types of stock-based compensation and considering factors like taxation, diversification, and your comprehensive financial situation, you can maximize the benefits of these assets while ensuring a secure retirement. Remember that careful planning, professional guidance, and a long-term perspective are the keys to successfully incorporating stock options and RSUs into your retirement plan.

Given the complexity of stock options, RSUs, and tax implications, it’s often wise to consult with a financial advisor or a tax professional who specializes in equity compensation planning. We can help you navigate the intricacies and make well-informed choices that align with your retirement goals.

Babylon Wealth Management excels in helping employees with stock-based compensation plans for a secure retirement. Our team of experienced financial advisors understands the complexities of stock options, RSUs, ESPPs, and other equity-based incentives. We work closely with clients to develop tailored retirement strategies that maximize the potential benefits of these assets while also mitigating risks. From tax-efficient exercise and sale strategies to diversification techniques and comprehensive financial planning, our experts provide guidance every step of the way. With Babylon Wealth Management, you can confidently navigate the intricacies of stock-based compensation to build a retirement plan that aligns with your financial goals, ensuring a prosperous and worry-free retirement future.

Tax planning when exercising your stock options and selling your company stock

Tax planning when exercising your stock options

Tax planning when exercising your stock options is essential to manage your tax risk, maximize your gains and avoid any unpleasant surprises with the IRS. If you are sitting on a pile of ISOs and NSOs, now is the time to consider exercising some of these grants.

The tax impact of exercising your stock options can be complex. There are many moving parts, and everyone’s circumstances are different. I am sharing some ideas with you on how to plan for exercising your stock options. Whether you aim to exercise at year-end or throughout the year, there is no one-size-fits-all strategy.

Feel free to make an appointment if you have any questions.

Exercise your ISOs up to the AMT breakeven limit.

Exercising ISOs are not subject to Federal and state income taxes, but you may pay Alternative Minimum Tax. The AMT is a parallel tax system that adds certain income, such as the ISO bargain element and the interest from certain types of Municipal bonds, to your regular income. Furthermore, the AMT system uses two tax brackets – 26% and 28%, respectively- with its own standard deductions. The AMT typically impacts just 0.1 percent of US households overall.

Most people receive an AMT exemption every year. The annual exemption is the difference between what you owe on your regular tax income and the AMT calculation. You may know it as AMT breakeven.

You can exercise enough ISOs annually to keep you under the AMT breakeven level. However, this annual AMT breakeven benefit is “use it or lose it.” You cannot roll it over for next year.

Suppose the FMV of your ISO is higher than your exercise price. This strategy could help you stay within a reasonable budget and start the one-year holding period on shares for favorable long-term capital gains tax treatment.

Exercise ISOs during high-income years.

The AMT breakeven point will likely be much higher if you have a significant windfall year. Let’s say you received a large bonus, sold your startup, or hit the jackpot. You will most likely be able to exercise a higher number of ISOs before you reach the AMT exemption.

Exercise NSOs to fill in your tax bracket.

Unlike ISOs, non-qualified stock options (NSOs) are subject to Federal, payroll, and state income taxes. Exercising a big chunk of non-qualified stock options can easily throw you in a higher tax bracket. In high-income tax states like California, your total payable tax can exceed 50%. You will end up keeping only half of your gains.

Depending on your tax situation, you can consider exercising just enough NSOs to keep you within your desirable tax bracket.

Use AMT credit by exercising NSOs or receiving RSUs

Once you pay AMT, you receive a tax credit, which will be payable to you in future tax years. Most people recoup their AMT taxes, but the exact timing depends on your specific circumstances.

You may have the entire suite of grants ISOs, NSOs, and RSU through your current employer or previous startups. If you have exercised ISOs in the past, you may have an outstanding AMT credit.

In that scenario, your AMT credits can offset the taxes you must pay for exercising NSOs or receiving RSU grants.

Exercise ISOs and NSOs with a low bargain element.

If you have recently received ISO and NSO grants, there is a good chance that the fair market value of your unexercised grants will be equal to or closer to the original exercise price. By exercising these specific lots with a small spread between FMV and exercise price, you may have a low to no bargain element. In that scenario, you may not owe any taxes. The downside of this strategy is that for more mature startups with appreciated FMV, exercising newer grants may require a higher cash expense.

Spread an exercise window across two tax years.

If your exercise window stretches between two calendar years, you can decide how much to exercise each year. Again, depending on your specific tax situation in the current and the following year, you can exercise a portion of ISOs and NSOs in December and then another lot in January.

83b election

83b election allows startup employees to exercise their stock options and other equity grants early and pay income taxes based on the Fair Market Value at the time of the election. You must file a one-page form to the IRS declaring your early exercise decision. The election entails that you exercise your ISOs and NSOs before they start vesting. Your primary benefit would be to avoid paying taxes on the growing spread between fair market value and exercise. If your exercise cost and FMV match at the time of your 83b election, you will avoid paying AMT on ISOs and income taxes on your NSOs. The downside is that you will be fully invested in your startup and need to put in upfront capital.

Prioritize long-term capital over short-term capital gains

Long-term capital gains receive favorable tax treatment. They are subject to a 15% or 20% tax rate. On the other hand, short-term capital gains trigger ordinary income tax, which is generally higher. You could pay over 50% in taxes in high-income states like California.

All else equal, prioritizing long-term capital gains can significantly impact your final outcome.

The moment when you exercise your NSOs and ISOs or receive your RSUs, and ESPP shares sets the clock on your holding period.

Each grant has different rules that make them eligible for long-term capital gains.

  • ISOs – 1 year from the exercise date and two years from the grant date
  • NSOs – 1 year from the exercise date
  • RSUs – 1 year from the vesting date
  • ESPP shares – 1 year from the purchase date and two years from the grant (offering) date

Tax-loss harvesting

Tax-loss harvesting is a strategy that aims to realize a loss on a position in your investment portfolio. You can use the proceeds to invest in similar security. However, when it comes time to pay your taxes, you can offset any gains from selling your company shares with realized losses from your tax-loss harvesting strategy. In addition, if your losses are bigger than your gains, you can use the remaining amount to offset up to $3,000 of your ordinary taxable income.

Let’s take an example:

You own 1,000 shares of company XYZ, which you acquired for $100 per share. The total cost basis is $100,000.

In addition to that, you own 10,000 shares from your employer ABC. The cost basis per share is $5

One year later, the price of XYZ dropped from $100 to $75, while the price of your employer shares is $20. You want to sell 2,000 of your company shares, but you want to avoid paying hefty taxes. If you sell your shares, your capital gain will be $30,000. You noticed that your XYX shares have dropped, and if you sell them, you will realize a loss of $25,000. Instead of paying capital gain taxes on $30k, you will only pay taxes on a 5k gain.

ABC capital gain

2,000 shares x ($20 – $5) = $30,000

XYZ capital loss

1,000 shares x ($75 – $100) = -$25,000

Total gain = $30,000 – 25,000 = $5,000

Don’t ignore the tax man

April 15 is the conventional deadline for tax filing. However, the IRS expects you to pay at least 90 percent of your estimated tax liability upfront. If you exercise your shares throughout the year are responsible for paying your taxes, including your AMT. There are four quarterly deadlines for making estimated payments in four equal amounts.

  • 1st payment …………….. April 15
  • 2nd payment ……………. June 15
  • 3rd payment …………….. September 15
  • 4th payment …………….. January 15

You might be subject to penalties if you owe a sizable amount and wait to pay it during the tax season.

Have a comprehensive plan.

The tax implications of exercising stock options can be complex. And there is little room for error. Through my years of experience helping my clients, I can share that the best strategy for you is to have a comprehensive plan. Before exercising your ISOs and NSOs, you must have a holistic view. There are many moving parts with any strategy. The most challenging part is predicting the future fair market value or exit price. Some of our clients have multiple grants from different companies,  various sources of income, or a high-earning spouse. Any additional layer of complexity can dramatically change your assumptions.

Essential Guide to Your Employee Stock Purchase Plan (ESPP)

Employee Stock Purchase Plan (ESPP)

What is Employee Stock Purchase Plan (ESPP)?

Employee Stock Purchase Plan (ESPP) is a popular tool for companies to allow their employees to participate in the company’s growth and success by becoming shareholders. ESPP gives you the option to buy shares of your employer at a discount price. Most companies set a discount between 10% and 15%. Unlike RSUs and restricted stocks, the shares you purchase through an ESPP are not subject to any vesting schedule restrictions. That means you own the shares immediately after purchase. There are two types of ESPP – qualified and non-qualified. Qualified ESPP generally meets the requirements under Section 423 of the Internal Revenue Code and receive a more favorable tax treatment. Since most ESPP are qualified, I will only talk about them in this article.

How ESPP works?

Your company will typically provide you with information about enrollment and offering dates, contribution limits, discounts, and purchasing schedules. There will be specific periods throughout the year when employees can enroll in the plan. During that time, you are required to decide if you want to participate and set a percentage of your salary to be deducted every month to contribute to the stock purchase plan. The IRS allows up to $25,000 limit for Employee Stock Purchase Plan contributions. Make sure you set your percentage, so you don’t cross over this limit.

At this point, you are all set. Your employer will withhold your selected percentage every paycheck. The contributions will accumulate over time and will be used to buy the company stock on the purchase date.

Offering period

Offering periods of most ESPPs range from 6 to 24 months. The longer periods could have multiple six-month purchase periods. Your employer will use your salary contributions that accumulate with time to buy shares from the company stock on your behalf.

ESPP look-back provision

Some Employee Stock Purchase Plans offer a look-back provision that will allow you to purchase the shares at a discount from the lowest of the beginning and ending price of the offering period.

Employee Stock Purchase Plan  Example

Let’s assume that on January 2nd, your company stock traded at $100 per share. The stock price had a nice run and ended the six month period on June 30 at 120. Your ESPP will allow you to buy the stock at 15% of the lowest price, which is $00. You will end up paying $85 for a stock worth $120.

The price discount is what makes the ESPP attractive to employees of high growth companies. By acquiring your company stock at a discount, the ESPP lowers your investment risk, provides you a buffer from future price declines, and sets a more significant upside if the price goes up further.

When to sell ESPP stock?

Some ESPPs allow you to sell your shares immediately after the purchase date, realizing an instant gain of 17.65%. Other plans may impose a holding period restriction during which you cannot sell your shares. Find out more from your HR.

ESPP Tax Rules

Employee Stock Purchase plans have their own unique set of tax rules. All contributions are pretax and subject to federal, state, and local taxes.

Purchasing and keeping ESPP stock will not create a tax event. In other words, you don’t owe any taxes to IRS if you never sell your shares. However, the moment you decide to sell is when things get more complicated.

The discount is as ordinary income

The first thing to remember is that your ESPP price discount is always treated as ordinary income. You will include the value of the discount to your regular annual income and pay taxes according to your tax bracket.

Qualifying disposition

To get a preferential tax treatment on your stock gains, you need to make a qualifying disposition. The rule requires that you sell your shares two years from the offer date and one year from the purchase date. Your gains will be taxed as long-term capital gains. The long-term capital gain tax rate varies between 0%, 15%, and 20% depending on your income. 

Disqualifying disposition

If you sell your shares less than two years from the offer date or less than one year from the purchase date, the sale is a disqualifying disposition. You will pay taxes on short-term capital gains as an ordinary income according to your tax bracket.

ESPP Dividends

Many publicly traded companies pay out dividends to shareholders. If your employer pays dividends, they will automatically be reinvested in the company shares. You will owe ordinary income tax on your ESPP dividends in the year when you receive them. Usually, the plan discount does not apply to shares purchased with reinvested dividends. Additionally, these shares are treated as regular stock, not part of your Employee Stock Purchase Plan.

Investment risk

Being a shareholder in a solid high growth company could offer a significant boost to your personal finances. In some cases, it could make you an overnight millionaire.

However, here is the other side of the story. Owning too much stock of a company in bad financial health could impose a significant risk to your overall investment portfolio and retirement goals. Participating in the ESPP of a company with a constantly dropping or volatile stock price is like catching a falling knife. The discount price could give you some downside protection, but you can continue to lose money if the price continues to go down. The price of General Electric, one of the oldest Dow Jones members, went down more than 65% in one year.

Remember Enron and Lehman

Many of you remember or heard of Enron and Lehman Brothers. If your company seizes to exist for whatever reason, you could not only lose your job, but all your investments in the firm could be wiped out.

You are already earning a salary from your employer. Concentrating your wealth and income from the same source could jeopardize your financial health if your company fails to succeed in its business ventures.

As a fiduciary advisor, I always recommend diversification and caution. Try to limit your exposure to your company stock and sell your shares periodically. Sometimes paying taxes is worth the peace of mind and safety.


Participating in your employer’s Employee Stock Purchase Plans is an excellent way to acquire company stock at a discount and get involved in your company’s future.

Owning company stock often comes with a huge financial upside. Realizing some of these gains could help you build a strong foundation for retirement and financial freedom. When managed properly, it can help you achieve your financial goals, whether they are buying a home, taking your kids to college, or early retirement.

Keep in mind that all ESPPs have different rules. Therefore, this article may not address the specific features of your plan.