Planning for Retirement with Equity and Option Compensation


Equity and option compensation is becoming a more common part of employee pay packages. With this comes additional considerations when thinking about saving for retirement.


The Basics


Contributions to an employer-sponsored plan, such as a 401(k), are the foundation of tax-advantaged retirement savings. Whereas these contributions are automatic, creating a plan for your equity and option compensation requires more proactive and consistent planning.


The bread and butter of retirement planning is saving in tax advantaged vehicles. It is important take the time to understand the contribution limits, employer match, and potentially an employee stock purchase plan. Once this is taken care of, you can begin to think about how to handle your equity and option compensation.


Addressing Concentrated Stock Positions


If you have stock options, equity grants, or an employee stock purchase plan, you may end up with a concentrated position in your company’s stock. In addition to the risks of holding a concentrated position, your cash compensation may be correlated with the performance of your company stock holding, which can have an outsized impact if anything goes wrong.


Once vested, concentrated positions that arise from compensation present a tradeoff: between diversification and potential tax consequences. It is the advisor’s job to discuss these tradeoffs with the client and come up with a long-term plan.


If you decide to diversify out of your concentrated position, taxes will be due. You’ll need to carefully plan a selling schedule to maximize tax efficiency. The longer the schedule is, the longer you’ll be exposed to the price volatility of the concentrated position. Creating a plan that can diversify while not generating an outsized tax bill will require careful planning. For more details on this process, check out our posts on managing concentrated positions and behavioral biases surrounding concentrated positions


The Bottom Line


Equity compensation is increasingly common and can be a great way to build wealth. It can represent the risk you take and the commitment you make when joining a firm that compensates its employees with equity and options, and can result in larger payoffs than traditional compensation. However, it comes with the traditional risks of concentrated positions, and the range of possible outcomes is much wider than than it is with traditional retirement savings. The ideal plan is to maximize both and let them work together so you can retire on your schedule and fund the life you choose in retirement.