Many employers, especially tech startups, use equity pay to attract and retain top talent. This turns the traditional paycheck on its side as workers face hard decisions in planning their financial future.
Paying people with company stock, whether in actual shares or other types of ownership, adds complexity. Because they're not receiving cash, participants in equity compensation plans confront more uncertainty than typical wage earners.
Misconceptions abound for employees. Staffers might assume they will eventually hit the jackpot after accepting a job that offers stock options or restricted stock units (RSUs).
"But it's a myth that you'll become rich," said Michael Kelly, a certified financial planner at Switchback Financial in Madison, Conn. "I make clients aware of why their employers use equity compensation. It's used for retention purposes, and employers may play on the behavioral biases of the employee."
For example, Kelly says that some employees have a "loyalty bias" or "confidence bias" when assessing their equity pay. They're wedded to their employer. And they're overly confident that their insider status enables them to evaluate the company's potential to soar.
He encourages clients to rein in their excitement and approach equity pay with sober analysis. This leads to a discussion about portfolio diversification, even if clients are initially inclined to go all-in on option grants.
Job candidates might treat equity pay as a golden ticket to wealth. When weighing offers from different employers, they might inflate the value of equity pay and overlook other key elements of the benefit package such as health insurance coverage and student loan debt repayment.
Mitigate The Risk Of Equity Pay
Advisors often find themselves cautioning clients not to rely on equity pay that's speculative in nature. It can require repeated warnings.
"You don't want to count on that money until it's actually there," Kelly said.
Depending on the type of equity compensation his clients receive, Kelly will work with them to analyze the employer's growth trajectory and likelihood of a big payoff. That's especially true with incentive stock options that are more complex than RSUs.
Scott McEachron, an advisor at McGill Junge Wealth Management in Clive, Iowa, finds that clients can believe deeply in their employer's mission and outlook. Such strong conviction can lead them to ignore the risks of maintaining a concentrated position in the company's stock.
"Nobody wants to think their company will fail," McEachron said. "They want to think everything will always go up, so we educate them about what else could happen and propose strategies to mitigate that risk."
To persuade such clients, he will cite examples of once-hot firms that hit turbulence in recent years after the initial buzz faded. Over the last year, some tech stocks lost more than half their value.
The sting of watching your company stock plunge can exceed the thrill of tracking its ascent. McEachron models both bullish and bearish scenarios in crafting a client's financial plan.
"If a stock goes from 50 to 100 versus 50 to 10, the impact is much greater with it going from 50 to 10," he said. There's no guarantee that employees holding a significant amount of their company's shares will recover from such a steep loss.
Advisors Share Equity Pay Tax-Smart Strategies
McEachron also strategizes with clients about how long to hold — and exercise or sell — certain types of equity compensation.
"We identify what amount of money we need to protect and how we take these chips off the table in a tax-efficient way," he said. "In some cases, setting up auto-selling can take away behavioral biases."
Advisors, often with the help of accountants, will explore the tax ramifications of equity pay. From the time an employee receives a grant of restricted shares, the clock can start ticking for certain tax filings.
For instance, McEachron may highlight the advantages of making an 83(b) election with the IRS. The client thus pays federal taxes when company shares are granted rather than when they vest.
"It can result in the client paying taxes at a lower rate than if they wait and exercise their options later," he said.
Advisors are well-suited to help clients negotiate their equity pay. But the window closes quickly: The best time to extract the most concessions is usually between getting the job offer and accepting it. Clients may not think to involve their advisor, especially if events unfold rapidly.
"Most clients utilize us as a resource when they're thinking of making a career change," McEachron said. "If they forgo company stock that has yet to vest — or are leaving a more established firm for a startup — they want to make sure they're not giving up more than they're getting (from their new employer)."
