In this article we will be discussing employer stock that you own from the various employee stock ownership plans such as Non-Qualified Stock Options (NQSOs), the various types of Restricted Stock Units (RSUs) , Incentive Stock Options (ISOs), Restricted Stock Awards (RSAs) and Employee Stock Purchase Plan (ESPP).
First – The Economics
We all (including many financial advisors) tend to get focused on the tax implications/cost of selling our stocks.Taxes are important but it should NOT be the first consideration. The first consideration is price. Why? Because taxes are only as much as 30% (federal and state) if you hold the stock for greater than one year. Most taxpayers pay less than 30%.
I will use the 30% combined federal and state income tax rate as an example. If you don’t sell your stock because you are worried about the tax bill and the stock price decreases by $1 per share, then your delay will cost you 70 cents on every dollar. Alternatively, if you sold at the $1 higher price you would have only lost 30 cents to taxes.
You must first review the economic situation for the company/stock and set the price that you will sell at.
Second – Establish the Plan
You have to decide on the number of shares, the price per share, and when to sell the stock.You have to have a plan.
For all types of shares if you don’t need the money in the next several years, it will impact your long-term game plan. Alternatively, if you need the money to fund a goal (e.g. college tuition, home improvements, a boat!, etc) this will obviously be the overriding factor. You won’t have time to speculate.
Warren Buffet and his partner Charlie Munger have called the lack of discipline to stick to the plan as “thumb sucking.” They have self-identified where it has cost them hundreds of millions of dollars. Even the best are not immune to not following their plan. It is essential for success.
The Number of Shares to Sell
This will/should be influenced by; if you need the money – how much, and what percentage the stock is of your total net worth. Most people should keep the percentage to the 5% to 15% range. The long-term stability of the company, stock price and the dividend yield will dictate higher and lower percentages. If you are more aggressive, willing to speculate, and you don’t need the money short or long term, then you can certainly hold more of the stock.
For example, Pfizer or Comcast stock, two company stocks we do a lot of planning for with our clients, you need to factor in that these companies and their stock prices tend to be stable. Especially in the case of Pfizer stock which has also had a very high dividend in these low dividend yield times
Multi-year tax planning can also dictate how many shares you sell. For example, you may want to maximize the lower tax brackets and not sell more shares which will push you into a higher tax bracket in a given year.
As noted, your need for the proceeds from the sale of the stock and the stability of the company and stock price are important factors in determining the plan. If the company stock price tends to be volatile you may completely exclude the tax implications in your long-term planning.
Also factor in, if the stock price hits an all-time high how many additional shares you will sell.
Price to Sell
This can be what a third party research company, such as Morningstar has established for what is the “Fair Value” of the stock. You should also look at the trading range of the stock. Stockcharts.com is a resource to review a stocks trading range. The trading range is something that most investors, including financial advisors, don’t consider.
All stocks trade within a range and have price support and resistance levels. When stocks rally they can become very overbought which is generally not sustainable long-term. Momentum can last for a while but you don’t want to push it.
A view of the trading range, as well as resistance prices, can provide a clue as to the sustainability of the high price. Alternatively, when a stock drops in price it can become oversold, also generally not sustainable long-term (unless a bear market and/or very overpriced). These are good things to know before you execute a panic sale. You will want to decide on the exit price beforehand, when you are not emotional. It is a business decision.
Once you set your target price, if your employer’s system allows it, you can place a limit order. A limit order defines the price that you want to sell the stock at. This removes emotions from the selling process (many people have a hard time pulling the trigger on the sale) and is more efficient than trying to make the sale while the market is fluctuating up and down. It is easy to miss the price that you had planned to sell for.
When to Sell
For Non Qualified Stock Options (NQSOs) and Incentive Stock Options (ISOs) this can be dictated by the expiration dates. You will certainly want to exercise before the exercise date, unless your shares are underwater (exercise price greater than fair market value).
If you own the stock (RSUs that have vested or ESPP for example) then when to sell will be based on price as noted above and the potential for selling after one year and receiving the lower capital gains tax rate. For a stable company’s stock, selling after the one year holding period can make a lot of sense.
Most employees will receive additional shares annually. Whether part of a compensation incentive program (NQSO, ISO, RSU, RSA) or if you are purchasing stocks through an ESPP. This allows you to consistently own shares, hold stock for a year or more and sell stock on a regularly scheduled basis.
After the stock is held for the 1 year holding period, the plan should be to sell the stock within the year, not necessarily on a specific date. The price can and mostly likely will dictate the date that you sell the stock.
Last – Tax Planning
The various tax considerations have been addressed previously in this article. The point I would like to make is that tax planning is the secondary consideration, after the economics of the stock price, etc.
It’s a lot to think about and seeking the help of a Financial Advisor to help you develop a plan with your employee stock, retirement planning or other wealth management services is a very good idea. You’ve worked too hard so don’t go it alone.
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