EQUITY COMPENSATION “KNOW-HOW”
FOR PHARMACEUTICAL EMPLOYEES
9 KEY FACTS to Understand When it Comes to Non-Qualified Stock Option Grants
EQUITY COMPENSATION
Have you ever wondered what the terms “stocks option,” “strike price,” “vesting schedule” and other terms mean in your employee package?
I did too when I joined the Pharma industry many decades ago. I wish I knew then what I know now because it does have an impact on my total financial plan.
At many pharmaceutical, biomedical and biotech companies, Non Qualified stock options are often offered and can be a valuable part of your compensation. The key is understanding their tax impact, when to exercise, and how these equity awards fit into your financial plan.
Read on to learn the ABCs of how to approach this unfamiliar topic – and don’t hesitate to contact me for a confidential conversation. I’d be happy to discuss your options and total plan.
Carolyn Choh, MBA Senior Financial Advisor
Financial Independence Planning, LLC (610)212-6203
NON-QUALIFIED STOCK OPTIONS (NQS): A PRIMER
Non-qualified stock options (NQs) are a common way companies reward employees. They give you the chance to buy company stock at a set price and potentially profit if the stock price rises.
Also known as equity compensation, many firms, including biotech, biomedical, biopharma and Big Pharma companies have used equity compensation as a way to incentivize employees to stay at their companies.
On the other hand, these industries often face downsizing cycles and if you are in that position, it may be a good idea to call your financial planner (ideally that would be me!) who is familiar with equity compensation.
At Financial Independence Planning, my colleagues and I have worked with many Merck employees as well as employees from BMS, Pfizer, GSK and some biotech and biopharmas.
If you receive NQs, it is important to understand how they work and how they affect your taxes, investments, and financial goals.
1. NQs Are Not Taxed When Granted
When you receive NQs, you do not owe any taxes. The company is simply giving you the option to buy shares at a set price for a certain period.
2. NQs Are Not Taxed When They Vest
Vesting means you are allowed to buy the shares. You do not have to exercise them right away, and there is no tax impact until you do.
3. You Owe Taxes When You Exercise
Once you exercise (buy shares at the set price), the difference between the stock’s market price and your exercise price is taxed as income. This is subject to income tax, Social Security, and Medicare.
4. Tax Withholding Varies
Your company will withhold taxes when you exercise your options. The amount depends on how many shares you exercise and their market value at the time.
For example, if you exercise 30,000 options at $10 each and the market price is $70, you owe taxes on $1.8 million. At a 37% tax rate, that is an impressive $666,000 owed to Uncle Sam.
5. You Have Ways to Pay the Taxes
The chances are slim that, in the example given above, you have $666,000 sitting in cash to cover the taxes. But you can sell some shares to pay for them (a sell-to-cover strategy). This ensures taxes are covered without using personal funds.
6. You May Owe More Taxes Later
If you hold onto shares after exercising, their value may change. When you sell them later, you will owe capital gains tax based on how long you held them.
• Short-term (held ≤ 1 year): Taxed as regular income.
• Long-term (held > 1 year): Taxed at a lower capital gains rate.
7. Options Expire If Not Used
NQs usually expire after 10 years. If you do not exercise before then, they become worthless. Make sure you check with your financial advisor (ideally that would be me) to update your options schedule.
8. Different Exercise Strategies Exist
You can decide when to exercise based on your goals:
• Wait until the last moment for certainty.
• Exercise when the stock price is high (though predicting peaks is hard).
• Sell enough shares to meet financial goals (like funding retirement or a big purchase). I have had clients sell some stock to pay off their own student loan, their children’s college tuition or to help pay for a wedding.
• Use a rolling exercise (exercising a set number of shares each year to spread out taxes). This can be automated and a great decision for many reasons besides taxes. It takes the emotion from the process and removes any sort of buyer’s /seller’s remorse should the stock price go up after exercising.
• Tax-focused strategies (exercising early to shift future gains to lower tax rates). This enables the future growth of the stock to be taxed as capital gains instead of ordinary income.
9. It is not always a bed of roses – Stock Options Might Not Always Be Profitable
If the stock price drops below your exercise price, your options lose value. If they stay below that price until expiration, they become worthless. That is disappointing but it does sometimes happen.
FINAL THOUGHTS
At many pharmaceutical, biomedical and biotech companies, Non-qualified stock options are often offered and can be a valuable part of your compensation.
When we at FIP build our clients' financial plans, we include vesting events and options expirations, so as to ensure meeting key dates. In addition to your 401(k) plan, pension, and savings, your equity awards can be a very meaningful part of your financial picture. The key is understanding their tax impact, when to exercise, and how these equity awards fit into your financial plan.
Please reach out to me, Carolyn@MyFIPadvisor.com, to explore your options and total plan.
ABOUT THE AUTHOR
Carolyn Choh holds FINRA series 66 and 7 registrations, as well as Life, Health and Disability insurance licenses with the State of PA. Carolyn has her BA in Biochemistry/ Asian Studies and an MBA from Cornell University.
After graduation, Carolyn joined the pharmaceutical industry where she held increasing responsibility in sales and marketing. Carolyn was a global product director at Wyeth and later Vice President at Saatchi & Saatchi. She transitioned her experience into teaching pharmaceutical marketing and was a professor at Saint Joseph’s University for over 10 years prior to joining Financial Independence Planning, LLC.
Carolyn is committed to the importance of life-long education. She has conducts financial education seminars focused on the topics of financial planning around life events such as:
• What to do When a Loved one or Spouse Passes
• 6 Steps when Faced with a Corporate or Life Transition
• Fabulous after Fifty – a Focus on Physical and Financial Health
View a video introduction and get to know Carolyn Choh at www.myFIPadvisor.com/Team/Carolyn-Choh or scan the QR code below.