On a regular basis, someone will reach out to Avrio Wealth to help organize and optimize their financial life. This might include investments, insurance, tax, college savings, estate planning, and more.
One common feature, especially amongst employees in Singapore, is stock compensation (stock options, restricted stock units [RSUs], and employee stock purchase plans [ESPP]).
Equity compensation can play an integral role in helping you achieve your financial goals, and it is important to plan properly to maximize its value.
- Gives you the right (or option) to buy a certain number of company stock shares at a set price determined on date of grant (grant price or strike price).
- Pre-tax value is the difference between current stock price and grant price, multiplied by the number of shares (example below).
- Taxed as ordinary income upon a trigger (i.e., exercise).
- Has the reputation of more risk, more potential for return, as they are leveraged. If current stock price is less than the grant price, the options are “underwater” and are worthless.
- Vesting typically occurs annually over several years (e.g., 25%/yr over 4 years) and they expire after a certain amount of time (e.g., 10 years).
Restricted Stock Units
- Gives you a certain number of company shares determined on the date of grant.
- Always has intrinsic value, provided the company is solvent. If the stock price is less than the price on the date of grant, the value will be less, but they still have value.
- On the date of vest, you receive shares, and they are taxed as ordinary income.
- They can vest annually over several years or on a cliff (e.g., 100% after 3 years).
Employee Stock Purchase Plan
- Enables employees to buy company shares through payroll.
- Some employers offer a discount to make participation more attractive (e.g., 15% discount from the market price).
- By holding stock for a certain amount of time, you can sell at favourable tax rates. Even if you sell immediately, on an after-tax basis, the gain might be 10% or more.
While employer stock can help you achieve great wealth (e.g., look at Google and Apple over the last 10+ years), it is important to have a plan in place to make the most of it and avoid risk.
1. Leverage—As mentioned, stock options are leveraged. Meaning, a 10% change in Apple stock price can have a 20% or 30% change in option value.
Example: In 2016, Marilyn was granted 100,000 shares of Coffee, Inc. stock options. Let’s assume the grant price was $100/share and the stock price has increased to $120/share, the value of the options is $2,000,000. If the stock price increases 10% to $132/share, the option value increases to $3,200,000 (60% change). However, if the stock price decreases 10% to $108/share, the option value decreases to $800,000 (-60% change). This 10% change can mean a $1,200,000 difference in value!
Leverage can lead to magnified increases/decreases in value.
2. Concentration—As the saying goes, concentration builds wealth, but diversification preserves it.
Owning a concentrated stock position can build great wealth, just look at Elon Musk. However, it is also important to ensure that the success of your wealth plan does not solely rely on the performance of one company, particularly one that your income and benefits are also tied to. Diversification allows you to “spread your eggs across multiple baskets,” which can maintain wealth over the long-term.
3. Time Horizon—When do you need cash? Do you have plans to buy a house on the Spanish coast in a few years? Is your eldest child starting to apply to colleges with $50,000/yr price tags?
Dedicating stock awards to specific goals can give you direction on when to exercise options or sell vested RSUs and employer stock.
4. Tax—There are only two certainties in life: death and taxes.
If living in the US, there is typically automatic withholding when RSUs vest or stock options are exercised (e.g., 100 shares of Apple RSUs vest, 30 shares are automatically withheld for taxes, and 70 shares are deposited into your stock plan account). However, for expats in Singapore, there is generally no automatic withholding, which can result in a big, unexpected tax due next year.
Additionally, if you are planning on moving from Singapore, expect to pay tax on unvested stock compensation to IRAS. The logic being, you earned the compensation while working here, you should pay tax on it here. This can also result in a big, unexpected tax bill. Proper planning-analysis can help prepare you for these liabilities.
5. Value Captured—When is a good time to exercise stock options?
This is often a difficult question to answer, as the value of stock options is determined by several factors including grant price, current stock price, time until expiration, risk-free rate (theoretical return rate of a zero-risk investment), dividend yield, and stock volatility (Black-Sholes methodology). A good target is to capture 90%+ of the full option value before exercising, depending on other factors.
While this is not an exhaustive breakdown on stock compensation and its considerations, it should provide you with direction on how to think about your stock to maximize its value for your goals. As Dale Carnegie said, “An hour of planning can save you 10-hours of doing.”
To learn more about how to plan for tomorrow, please reach out to one of our wealth planners. Avrio Wealth has sophisticated equity compensation planning tools to help you make informed decisions.
This material is intended for educational and informational purposes only. It is not intended to provide specific advice or recommendations for any individual. Additionally, you should consult with your Financial Advisor, Tax Advisor, or Attorney on your specific situation. The views expressed in the material are that of the author and do not necessarily reflect those of any market, regulatory body, State or Federal Agency, or Association. All efforts have been made to report or share true and accurate information. However, the information may become materially outdated or otherwise rendered incorrect due to subsequent new research or other changes, without notice. The author nor the firm are able to always verify the content from third-party sources. For additional information about the firm, please visit the MAS Website at https://www.mas.gov.sg/ and the SEC Website at www.adviserinfo.sec.gov. For a copy of the firm's ADV Part 2 Brochure, please contact us at firstname.lastname@example.org.