Spring is a time of renewal. As bulbs that have lain dormant all winter burst into bloom, gardeners take stock of what has survived the cold months and look to make sure everything is coming out as intended. Spring is also a great time for advisors to do the same kind of checkup with clients.
One of the things I always like to do with corporate executive clients at this time of year is to look at their incentive stock options (ISO). If the client has faith in the company’s long-term prospects and believes that the stock is undervalued, this would be a good time to exercise those options. The thing to keep in mind is that the difference between the market value of the stock on the exercise date and the exercise price counts as income. Depending on the amount, that gain may be subject to an alternative minimum tax (AMT) payment. The good news is the client will not have to write that check until April 2024.
This is also the time of year when many companies offer performance reviews for the previous year and bonuses, if earned, are paid out. This period may also be when restricted stock grants based on performance are issued. And for long-serving employees, this is likely also the time of year when vesting of grants from earlier years occurs.
This is another area where I encourage the client to think carefully about how we address these stock grants. In many cases we urge clients to withhold granted shares with a value equal to the tax due on the grant. That is the easiest way to handle it and there is no cash out of pocket.
But if an executive believes their company stock price to be low, they are technically selling the stock at a low price by withholding shares. A lot of employees do not want to pony up the 40% with real cash, but for those who believe in the long-term health and strength of the company, it is a good move.
But, if, as mentioned earlier, the executive believes the price of their company’s stock is low, by withholding shares they are technically selling at under-valued prices. In that case, it may make more sense to consider using cash to pay the tax obligation, especially if the stock you own pays a dividend, which in the current environment may offer a better return than cash right now. I often tell clients, “If you believe in the long-term health and strength of your company, it’s a good move. It’s an aggressive mood, but a good one.”
Every year we have at least one younger client who is receiving a stock grant for the first time, which is a big day for a corporate executive and one deserving of congratulations as it highlights the passage of a major career milestone. If they stay with that company, they are likely to be offered more opportunities to participate in the company’s success through restricted grant options and performance shares.
With those clients, we explain how stock grants work, in addition to when and how to exercise them. We also talk about the decisions that are going to have to be made in the future when the stocks vest. We make sure to get from the client their vesting date, what the grant consists of and other details so we can be proactive in working with that client to maximize the benefit to them.
With the market basically flat or languishing, as it currently is, another thing we discuss with clients who own stock positions in their companies, is to see if they can write covered calls against their stock positions. In most cases, that is not a tactic available to senior management, but employees outside the C suite may be able to leverage this strategy, and their company stock administrator should be able to determine eligibility. If allowed, this is another method of generating income from their employee stock.
We also encourage corporate executives to take a good look at all their 401(k) plans to make sure their portfolio is appropriately allocated and that they are maximizing both their own and their employer’s contributions. For individuals who may be approaching retirement, a traditional 401(k) can be especially advantageous because it allows the individual to put money away pre-tax. When they begin to withdraw those funds after they stop working, they will most likely be taxed at a lower rate.
And, as always, when we touch base with clients we sit down and review their goals. We look at their personal expenditures, talk about funding 529 plans for their children or grandchildren, and their long-term savings. Probably the most important thing we do in that meeting is work with the client to accurately plan out cash flows throughout the year. I never want to see a client have to use their bonus to pay their tax liability from the previous year. I tell them that money should be for the future, not settling past liabilities.
Kenneth Van Leeuwen, CFP, is managing director of Van Leeuwen & Company, the wealth management firm he founded in Princeton, N.J., in 1997.