| ||||||||||||
We all need money management advice, whether you’re an experienced investor or a young executive starting out. MassMutual’s team is here to help.
Today’s insights on handling major stock awards from work come from Douglas Collins, a financial planner with Fortis Lux Financial in New York City.
Q: I’m getting a large part of my compensation in a yearly stock award. How do I handle that?
A: This is a common challenge for executives these days, as more and more companies are trying to tie pay to performance. C-suite leaders and executives at large publicly traded companies often receive a large amount of their compensation via stock awards. And more and more mid-level managers are starting to get this kind of compensation as well.
Such programs can present investment, risk, and protection challenges. You need a strategy to meet those challenges …
First, understand how the awards work. Typically, they can come in the form of stock options or restricted stock units (RSUs). For this discussion, let’s envision someone who receives RSUs as part of their annual compensation. More often than not, RSUs will have a graded vesting schedule after one year. For example, a client who is awarded 150 shares in February 2026 will vest 50 shares per year at the start of 2027, 2028, and 2029.
When the shares vest, the value on that date becomes taxable income for the employee receiving the shares. Companies will often withhold shares to account for taxes. So, of the 50 shares that vest, the client may have 30 shares deposited into their holding account. Keep in mind that as time goes on, the client may be receiving shares from different years' awards as well.
If the employee were to be terminated or leave the company voluntarily, they would probably lose any unvested shares. That’s part of the point of these programs – to incentivize a valued employee to stay with the company.
If the employee were to die while still employed, their unvested shares could potentially be paid to a named beneficiary, but that depends on the program’s terms.
This can really affect your protection needs. If death does not trigger vesting, any unvested lost shares must be accounted for when determining how much life insurance a person needs. Check the terms of your award. Then check what your family might need if it wasn’t there.
This includes disability needs too. Most large companies have a group disability income insurance policy that provide a benefit that is roughly 60 percent of base salary up to a certain dollar amount per month. But many group disability policies do not cover any compensation outside of base salary, so any unvested or future stock awards will not be considered in the event of a long-term disability.
If cash bonuses and/or stock awards make up a large portion of an employee’s compensation, it is crucial to account for the awards when determining if their group policy is adequate, or if they need to obtain some form of executive disability carve out or an individual policy to help cover that lost income.
Handling risk and value of the stock award. Once the award has vested and applicable withholding have been applied, the employee can choose to hold the stock or sell it. There are exceptions sometimes, depending on the employee’s role at the firm, to either have an additional restricted period or certain “windows” in which they are allowed to sell. In some cases, companies may also restrict certain types of transactions—such as options contracts or other hedging strategies—or require pre-clearance prior to trading. In addition, these types of strategies are often not permitted on unvested or otherwise restricted shares.
Many times, employees retain their stock awards, and these accumulate over time to a point where the employee may become highly overexposed to one concentrated stock position as part of their overall portfolio. When I get such a new client, someone who has accumulated many years of stock awards, it can present an interesting problem:
- Selling shares all at once to de-risk the portfolio would trigger a significant capital gain tax.
- But retaining the concentrated stock position could have material risk, including the potential for significant loss in value.
One way to help manage this risk in certain circumstances is a zero-cost collar option strategy around these shares, which may be implemented without necessarily triggering immediate tax consequences, depending on individual circumstances. Before using options strategies like this, it is important to confirm they are permitted under your company’s policies—such as your insider trading policy or equity award agreement—and to review any required pre-clearance or trading window rules.
Essentially, a third-party manager sells a call and buys a put on the shares at a net cost of zero (subject to market conditions, pricing, and fees) to help set a range for potential gains and losses.
- Should the stock lose significant value, the put options may help limit losses during a downturn.
- Should the stock appreciate quickly, the call options may result in the shares being sold at a price higher than what the employee was granted for the stock, but will limit participation in further upside, above-the-call strike price.
By potentially reducing volatility, shares may be sold over time to help de-risk the portfolio. In some cases, certain hedging strategies—such as options-based strategies—may result in earlier recognition of taxable gains depending on how extensively the position is hedged.
(Options involve risk and are not suitable for all investors. Certain options strategies, including collars, involve trade-offs such as limited upside and ongoing costs or risks. Please read the Options Disclosure Document (ODD) before investing.)
A charity option. Another way to decumulate company stock awards that have highly appreciated include considering charitable gifts of shares to a donor-advised fund (DAF). This may be a consideration for an employee who is close to retirement and wishes to be philanthropic.
By lumping many years of planned charitable gifts into one tax year via a DAF, the employee may be able to take advantage of two different tax benefits.
- First, they may be eligible for a potentially large income tax write off while at peak earnings before retirement.
- Second, any unrealized capital gain that has accrued while holding the vested RSUs for more than one year is generally not recognized at the time of donation when shares are directly donated into the DAF.
Working with a tax advisor is crucial for this strategy as there are limits on deductions based on income and differences in treatment between donating appreciated stocks or other property versus cash. Keep in mind this is an irrevocable donation and the grantor cannot take any property out of the DAF.
Once the lump sum charitable contribution has been made, the employee can diversify out of the concentrated stock holdings without incurring capital gains tax on the donated shares. Disbursements to qualified 501(c)(3) organizations do not have to made immediately, so donations can be distributed from the DAF over a number of years.
Conclusion
The executives who get the most out of these programs aren't necessarily the ones with the biggest awards — they're the ones who take the time to plan around them. That doesn’t happen on autopilot. You need to read the terms of your award carefully, understand what your family stands to lose if something goes wrong, and sit down with a financial professional, a tax advisor, and potentially a legal professional to evaluate how all the pieces fit together.
More Q&A from MassMutual …
Q&A: How can I use my inheritance to help build wealth?
Q&A: What’s the best strategy for parents saving for college?
______________________________
