Equity compensation, also known as an ownership stake in the company, has become a crucial benefit in today’s competitive job market. A recent survey conducted by Morgan Stanley revealed that 72% of companies now offer some form of equity compensation to their employees, which is a significant increase from 65% in 2021. This type of benefit is designed to motivate employees and help them achieve their long-term investing goals. However, according to certified financial planner Chelsea Ransom-Cooper, many individuals miss out on this opportunity simply because they do not fully understand it.
Types of Stock-Based Compensation
There are three popular types of stock-based compensation that employees typically receive. The first type is stock options, which give individuals the right to buy company shares at a preset price within a specific timeframe. This is commonly seen in startup companies, where stock options are used to create an ownership culture and provide employees with the potential for significant wealth. However, the tax implications of stock options can be complex, depending on whether they are incentive stock options or nonqualified stock options.
Incentive stock options offer certain tax benefits, but they may trigger the alternative minimum tax for higher earners. On the other hand, nonqualified stock options generally have less favorable tax treatment, and individuals will owe regular income taxes on the discount upon exercise. Despite the potential value of stock options, there is always a risk that the company’s stock price may decrease after exercising them, rendering them worthless.
Another common form of equity compensation is restricted stock units (RSUs), which are company shares granted upon hiring and vest over time. RSUs can also be tied to performance-based goals, making them a valuable incentive for employees. Upon vesting, individuals must decide whether to sell or hold onto the RSUs based on their short- and long-term investing objectives.
Employee Stock Purchase Plans (ESPPs)
Many publicly traded companies offer discounted company shares through an Employee Stock Purchase Plan (ESPP). This type of plan allows employees to purchase company stock at a discounted rate, providing them with an opportunity to invest in their employer’s success. ESPPs are often considered a valuable benefit, offering employees the chance to earn “free money” through the purchase of discounted shares.
However, participating in an ESPP comes with risks, particularly when investing in a single company. Financial experts caution that there is always a significant risk associated with investing in a single stock, as there is no guarantee of making a profit. It is important for individuals to carefully assess their short-term financial goals before enrolling in an ESPP and consider other investment options, such as a 401(k) match, before allocating a significant portion of their income to company stock.
Equity compensation has become a critical component of today’s workplace benefits, offering employees the opportunity to share in their company’s success and achieve their long-term financial goals. By understanding the different types of stock-based compensation available and carefully evaluating the risks and benefits associated with each, individuals can make informed decisions about their financial future and maximize the value of their equity compensation.