You could ‘miss the opportunity’ with company stock, experts say. Here are the key things to know

As employers compete to attract and retain talent, equity compensation — or an ownership stake in the company — has become a key workplace benefit.

Some 72% of companies offer some form of equity compensation to certain employees, a 2023 survey from Morgan Stanley found. That’s up from 65% in 2021.

These perks motivate employees and boost their long-term investing goals, according to the Morgan Stanley survey, which polled 1,000 U.S. employees and 600 human resource executives.

However, some “miss the opportunity” because they don’t understand it, said certified financial planner Chelsea Ransom-Cooper, chief financial planning officer for Zenith Wealth Partners in New York.

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Here’s what to know about three popular types of stock-based compensation, experts say.

Many employees receive so-called stock options as part of their compensation, which are the right to buy or “exercise” company shares at a preset price within a specific timeframe.

“It’s almost iconic to grant stock options in a startup private company,” said Bruce Brumberg, editor-in-chief and co-founder of myStockOptions.com, which covers various types of equity compensation.

Startups want to create the drive and incentive of ownership culture with the potential for “life-changing wealth,” he said.

Stock options become valuable when there’s a discount between your preset price and the market value, which makes it more attractive to exercise. However, the taxes can be complicated, depending on the type of stock options.

Incentive stock options can offer some tax benefits — if you meet certain rules — but could trigger the alternative minimum tax, a parallel system for higher earners.

By comparison, the more common nonqualified stock options generally have less favorable tax treatment and you’ll owe regular income taxes on the discount upon exercise.

But even with an initial discount, there’s no guarantee a company’s stock price won’t decrease after exercising a stock option.

“It could be worth nothing but a piece of paper,” Ransom-Cooper from Zenith Wealth Partners said.

Another benefit, restricted stock units, or RSUs, are company shares granted upon hiring, which vest over time. RSUs can also be tied to performance-based goals.

Some 94% of public companies offer RSUs to at least middle managers, according to a 2021 survey from the National Association of Stock Plan Professionals.

“I like to think of it like a cash bonus,” said Pittsburgh-based CFP Matthew Garasic, founder of Unrivaled Wealth Management. 

For example, if the stock price is $10 and 100 shares vest, it’s treated like $1,000 in compensation for that year, and the standard withholding of 22% might not be enough, depending on your tax bracket, he explained.

After vesting, the decision to sell or hold RSUs depends on your short- and long-term investing goals.

“We like to establish a target of what they like to hold in company stock,” said Garasic, who aims to keep allocations of a single stock to 10% or less. “Once we get above that target, we just sell at vest.”

Many publicly traded companies may also offer discounted company shares via an employee stock purchase plan, or ESPP.

“There’s free money to be had” with an ESPP, Garasic explained.

However, the decision to participate typically depends on your short-term financial goals.

After enrolling, your ESPP collects a portion of after-tax money from each paycheck and uses the funds to buy discounted company stock on a specific date.

The gold standard is a 15% discount with a lookback feature, which bases the stock purchase price on the value at the beginning or end of the offering period, whichever is lower, experts say.

You can typically sell after a set period, but there’s no guarantee you’ll make money, even with the built-in discount.

“Any time you’re investing in a single company, there’s certainly a big risk,” CFP Kristin McKenna, president of Darrow Wealth Management in Boston, previously told CNBC.

Yearly goals like investing up to your employer’s 401(k) match should come before your ESPP, especially with limited income, she added.