While complicated valuations, market volatility, and increased regulation have reduced the appeal of stock option plans in recent years, restricted stock plans are rising in popularity as an employee compensation and retention tool. Unlike options, Nobel Prize winning math isn’t required to understand the value of the award, and they carry less risk and complication for the employee. Although you don’t enjoy the same leveraged opportunity as with stock options, as long as your company stock is trading above $0, you’ll receive some value for the restricted stock award. Understanding the details of your plan is critical to build a strategy for your restricted shares. Taxes, overall investment allocation, and estate planning are three areas where proper planning is required to ensure you get the most from your restricted stock award.
Congratulations! Now, Here’s Your Tax Bill
When you receive your grant, you’ll know what day(s) they vest. This is important, as the value of the shares are subject to ordinary income taxes on the vesting dates. Typically companies will withhold payroll taxes, however, in many cases a flat federal rate of perhaps 25% is the default, along with a particular state tax rate. Prior to vesting, it’s wise to have your CPA run a projection to determine what level of federal and state income taxes you will likely be subject to for the year, especially as the value of the vesting shares may bump you into a higher tax bracket, creating an unpleasant tax surprise.
Set a plan for how you’ll come up with the money to pay the extra taxes. In some cases, your employer may allow you to withhold a higher percentage than the default levels, resulting in fewer net shares received. If not, and if cash flow is in short supply, planning to sell some of your new shares immediately and setting the cash aside is an option; but be sure to understand when your trading windows will open if you are considered an Insider or are subject to trading restrictions. However, don’t forget about the big picture. If you think the stock has the potential for strong growth, selling shares or extra share withholding may not be the best solution. There could be other areas of your balance sheet that may be more feasible to draw from to cover the tax bill.
Try Not to Over-Concentrate
Restricted stock can also increase the concentration of your total resources — including human capital — in your company. Your income, along with the value of any stock positions in your company, is reliant upon your employer’s solvency and future growth prospects. If you already have company stock, especially if you are an executive with share requirements, create a diversification strategy based on the asset allocation of your total investments. Large concentrated employer stock positions can overweight your portfolio toward one security, increasing risk and volatility. Take a disciplined approach to diversification when restricted shares vest and shape your portfolio to suit your needs and risk tolerance. Finally, if you have charitable intent, donating appreciated unrestricted stock to a charity, donor-advised fund, charitable trust or private foundation can not only reduce your tax bill but may also help your overall diversification strategy.
Don’t Forget About Estate Planning
The wrong beneficiary designations can wreck the most carefully constructed estate plan. As estate tax laws change, so does the need to revisit how your restricted shares will impact your planning. If your company’s stock plan allows you to name beneficiaries, work with your estate attorney to determine how your designation paperwork should read. Usually if no beneficiary is named, the stock will pass to your estate, further emphasizing the need for coordinated wills and trust documents. Finally, most restricted stock plans have provisions that allow for accelerated vesting at an employee’s death, which can potentially trigger tax issues for the estate and the beneficiary.
Restricted stock plans can be of great value for employees and employers. If you’ve been granted restricted stock or have shares that are about to vest, contact your financial advisor to discuss the tax, investment and estate planning issues that you may face. With proper planning, you can get the most out of your restricted stock awards, without restricting your opportunity.