Restricted stock is much simpler than stock options in terms of equity compensation. Restricted stock refers to stock that has been given to an employee but cannot be transferred unless certain conditions are met. These requirements may be dependent on time or efficiency.
Restricted stock is also common among corporate profit groups. Since the early 2000s, a large number of publicly traded companies have switched from offering stock options to issuing restricted stock. Employers hope that these grants will enable them to provide excellent wealth-building opportunities. In reality, in Charles Schwab’s 2017 Equity Compensation Plan Participant Survey, the total value of the participants’ stock compensation was $72,245 and nearly two-thirds of the participants were completely vested.
The road to turning restricted stock into true wealth, like Charlie’s journey into the Chocolate Factory, can be long and winding. Though restricted stock has a lot of upside potential, workers who don’t understand how to handle the risks can not reap the full benefits.
Unprepared to Face Tax Issues
One of the most pressing issues identified by Schwab in its survey is that half of workers want more information on the tax consequences of restricted stock.
“We grasp the fundamental principles of these grants since they are straightforward. When the limitations expire at a later date, the employee retains a specific number of company stock shares,” says Bill Dillhoefer, CEO of Net Worth Strategies Inc, a provider of specialist equity compensation risk analysis and tax preparation resources. “However, the tax implications of vesting may catch workers off guard.”
Restricted stock is handled similarly to bonus withholding in terms of tax withholding since it is ordinary revenue. For both federal and state purposes, corporations must use statutory withholding rates. Employers are only allowed to deduct 22 percent of workers’ total pay for federal purposes if their total compensation is less than $1 million. Employees in higher tax brackets can face difficulties as a result of this.
In addition, each state determines its own statutory rates. In California, for example, the majority of taxpayers are in the 9.3% tax bracket, but these prizes are withheld at 10.23%.
Most workers face an unusual tax situation at tax time: they are breakeven or even have a modest refund for state purposes, but they owe a federal balance. Many people are irritated by this, especially if the proceeds from the shares have already been spent.
Restricted stock tax preparation should be as simple as the awards themselves. Although it is always advisable to consult a tax professional, workers may perform a simple calculation by multiplying their gross award by their tax rate.
For example, if an employee’s 1,000-share grant vests at $10 per share, the total reward is $10,000. The corporation would withhold 22 percent of its shares, or $2,200, for federal purposes. However, if the employee is in the 32 percent tax bracket, their liability is about $3,200. Although this is just a guess, it allows the employee the ability to set aside the appropriate sum for their tax bill. Employees will take care of their tax situation with this back-of-the-envelope preparation.
Should I Buy or Sell?
The receiver must decide what to do after the stock vests and the net shares are deposited into the employee’s brokerage account. Employees sometimes believe they have only two options: sell now or keep a concentration spot. According to Schwab, half of the workers polled were worried about making a mistake while selling company stock. It’s clear that this is a difficult decision to make.
Both courses of action have advantages and disadvantages. Those who sell right away reduce the risk of a single stock’s volatility and provide liquidity for diversification. Many who hang on to their shares, on the other hand, are looking for a return on their investment.
Both approaches are short-sighted, inefficient, and dangerous, according to Dillhoefer.
A third approach, according to Dillhoefer, is to sell shares in a systematic manner. The StockOpter tool from his company can help set criteria for when a stock is sold and the proceeds are invested in a diversified portfolio. When modeled out, an employee might decide to sell 10% of their stock holdings and transfer the proceeds into their investment account when the stock hits certain prices.
“Advisors can model company share diversification strategies that address financial targets and reduce risk using stock compensation analysis software,” explains Dillhoefer. “It shows how a small rate of diversification will reduce the risk of a concentrated company stock position over time, using simple tax and growth rate assumptions.”
Budget Creep Shouldn’t Stop You From Building Wealth
However, taxation and investment plans aren’t the only factors to consider when optimizing restricted stock awards. Employees must instead add one more element to the mix: budgeting. An employee should concentrate on using wage benefits to cover daily living expenses if they have a good understanding of living expenses. When the restricted stock event happens, the wealth creation process will really get started.
The funds should be allocated to various areas of the employee’s financial plan. An employee, for example, could divide the proceeds between paying the remaining tax owed, contributing to their child’s 529 plan, and increasing their investment account. Instead of making the proceeds go to cash flow, these strategic allocations enable the employee to make progress against financial targets.
The Best Way to Go Is to Have a Strategy
It’s like being a kid in a candy store when you get restricted stock. However, without the proper tax, procurement, and spending policies in place, it becomes a squandered opportunity for wealth accumulation. Your golden ticket will not be squandered if you catch and exploit the situation.
