WRITTEN BY: Gideon Drucker, CFP® AIF® ECA

As many of you know, receiving stock options from your employer can be a wonderful way to build long-term wealth... but it also means a whole host of financial, tax, and investment decisions you have to make (and make quickly) to actually realize the benefits!

In the coming weeks, we're going to provide a bit of a "behind the scenes" look at how we guide clients through ALL of these stock option decisions and opportunities from all vantage points (cash flow, tax outcomes, investment strategy, and execution).

So you know where we're coming from (I'm not normally so blatantly self-promotional, but I do think this is an area where real, hands-on experience matters, so I'm not holding back here):

We have helped clients with stock options at pre-IPO companies (Anthropic, OpenAI, Scale AI).
We've helped clients through their companies' initial public offerings and lock-up periods (Figma, Airbnb, Uber).
We've worked with clients after they built up concentrated positions in large, established publicly traded companies (Google, Meta, Apple, Walmart, etc.).
We have two in-house CPAs who are well versed in guiding clients through AMT calculations, addressing double-trigger RSUs, and modeling out scenarios based on your most recent 409A valuation.
The first designation I earned after my CFP was my Equity Compensation Associate (ECA).

Simply put, we LOVE working with folks who have stock options!

OK, here we go. I'll start by saying that we will, later on, get to the technical side of things: exercising ISOs up to the AMT limit, understanding the leverage in your NSOs, balancing tax savings vs. concentration risk... it's all important, but starting with any of that would be doing you a disservice. (And for what it's worth, I actually think that way too many financial advisors, CPAs, and the like, in trying to show how much they know about taxes, go RIGHT to the tax calculation piece without thinking about the bigger financial and investment picture... which means a potential outcome where you save $3 in taxes but miss out on $6 as a result. Don't worry, we'll get there!)

If we zoom out, the entire reason you are working so hard to have the opportunity to vest and exercise stock options is clear:

Use this (potentially life-changing) money to reach your financial goals and become financially independent.

The key is in turning these (at present) hypothetical and risky single-company stock options into wealth that can't be taken away.

We work through the following framework:

What are your financial goals and priorities as you think about the next 30 years? (Buying a home, taking a sabbatical, fully funding college costs for your children, being work-life optional by 55, etc.)
How much money will it take to reach those goals?
How much of these goals can already be funded WITHOUT any of this company stock or these options? (I.e., based on your existing assets, saving capacity, compound interest, etc.)

From this, we start to arrive at a broad understanding of how to THINK ABOUT this money as part of your broader plan. If we strip away all nuance (just for the sake of illustrating the framework), we arrive at a decision tree that looks like this:

Sell enough company stock to fully fund your life goals regardless of what happens to the company...

This is the most important piece of the conversation, and I think people sometimes lose sight of it once they start imagining these huge hypothetical dollars rolling in. If you know that you need $5M to fully fund your lifestyle, your family's goals, and everything you're committed to... we want to protect THAT amount of money before doing anything else.

If you can use your stock options to accomplish your financial life goals... congrats, you've won the game!

Consider keeping stock only to the extent that you don't NEED this money to reach your version of financial independence

The key word here is "consider," because we are certainly not advising someone to hold more concentrated stock in their company simply because they "can." Everyone's capacity and desire to hold concentrated stock is different. But if you are bullish on your company and are comfortable with the increased risk, this formula is a thoughtful way of preserving your upside in your company in a way where your downside is protected.

I'll use real client examples as an explainer:

You're 45 years old, married with 3 kids, with a net worth (not including your primary home) of $1.5M and stock options worth approx. $5M. With this fact pattern, you might readily consider selling most/all of your options post-IPO because you have a relatively low risk capacity (the amount you're able to lose without it affecting your financial habits and lifestyle).

Cashing in your chips (so to speak) and taking that $5M and redeploying it into a combination of cash (for short-term needs) and diversified equity investments (to outpace inflation and grow your money for your long-term needs) can provide you the means to do everything you want... as opposed to keeping money in a single stock and accepting additional risk that you can't afford, all in order to earn returns that you don't truly need.

While it might be nice to see if that $5M can turn into $10M or $20M, your financial plan is DEPENDING on utilizing the $5M that you can stash away right now!

This concept of risk capacity as a function of your lifestyle, assets, and earning potential can be found on our podcast here: [LINK]. I think it is foundational to this conversation.

On the other hand, we've worked with clients who are on their second/third potential liquidity event and so have the means (risk capacity) to take a swing toward future upside. Consider this profile: You're 34 years old, have no kids (yet), and you already have a $4M net worth from a previous company exit, and those assets are largely diversified and balanced for long-term growth. Given this fact pattern, if you're bullish on your company and understand the risks... you're in great shape to hold more of your options/stock in the hopes that it 10x's and leads to significantly more wealth! Even if it doesn't, you're still on track to accomplish all of your goals... you can afford for this money to be your home-run swing!

This is generally NOT our recommendation. We are of the mind, based on all available history of investing in single stocks, that you are better off selling, diversifying, and turning hypothetical money into real, sustainable long-term wealth... but part of our job is letting clients know when they are in a position to take on more risk IF THEY WANT TO, and to what degree they can, based on the rest of their financial outlook.

Before we move on, we should probably spell out the investment principle that's running through this framework: Having a meaningful amount of your wealth invested in one single stock is incredibly risky. Only 4% of companies have been responsible for ALL OF THE GAINS above risk-free Treasuries over the last 100 years... think about how crazy that is! Most companies simply go out of business or end up not making any more money than a conservative Treasury... the idea that your ONE company is going to be one of the winners over the next 30–40 years (which is the time frame in which we need your money to grow) is incredibly unlikely. And I understand someone at Anthropic or OpenAI (like Google or Meta before it) looking at me with that "Jim from The Office" expression... yes, your company is the unicorn of today... but nothing is guaranteed! As evidence, go look at the top 10 holdings of the S&P 500 in 1996 (30 years ago) and then look at what they are today... there's only ONE company of overlap. Believe it or not, this is likely to happen 30 years from now as well!

So, broadly, our investment philosophy for building wealth is simple: "Instead of trying to find the needle in the haystack... buy the haystack!" – Jack Bogle

OK, so now we have our framework for how much stock we ULTIMATELY want to sell (enough to fund your life goals) and how much we want to keep (the amount you don't need to fund your goals, if you really want to hold it), but how do we actually go about it?

I think the most helpful way of showing how we might tackle your stock options (unpack the tax implications, strategize around exercising and selling, and so on) is to create a case study.

Let's assume you have the following equity package:

5,000 Incentive Stock Options (ISOs), vesting quarterly, with an exercise price of $10 per share
1,000 Non-Qualified Stock Options (NSOs), vesting quarterly, with an exercise price of $10 per share
1,000 double-trigger Restricted Stock Units that vest monthly over 4 years

And we'll assume the company is still private and the most recent 409A valuation was $15.

First, let's walk through what you have and the differences between the different types of options and equity. (If you are comfortable with the mechanics and tax treatment of stock options and want to dive straight into planning and strategy... skip the next part and start with "How to Think About Exercising.")

Let's get the basics out of the way so we can get to the good stuff:

Stock Option Basics

When you hold ISOs and NSOs, you are holding the OPTION to buy stock at a particular price ($10) even though the stock is actually valued at $15. And even when the valuation goes up to $20 per share or $50 per share, you keep the OPTION to buy the stock at $10... awesome! Receiving stock options does not come with a tax bill, and the vesting period stated above simply refers to WHEN you are able to exercise (buy) your options... you have to wait until your options are vested before you even have the chance to exercise them. (We're putting aside early exercises and 83(b) elections for the moment.) You never HAVE TO exercise your stock options (though if you never exercise them, you get nothing out of them), you usually have 10 years from the initial grant to exercise, and most companies give you 90 days upon separating to exercise your options.

NSO Tax Treatment

You pay ordinary income tax on the difference between what you paid for the stock (the exercise price) and the fair market value... this difference is called the discount element. So, in our example, if you exercise 100 NSOs at $10 per share when the stock is valued at $15 per share, you will pay ordinary income tax on $500 ($5 discount x 100 shares).

If you exercise those 100 NSOs when the stock is up to $50, you'll pay ordinary income tax on $4,000. Then you hold the stock... from that point forward, the tax treatment on that stock is just like any other stock you might own. If you hold it for at least a full year, you'll pay capital gains when you eventually sell, etc.

NSOs are simple because there is no special tax treatment to speak of... you are simply responsible for ordinary income tax on the FULL amount of the spread on your stock options. We'll dive into when to exercise and how to plan with your NSOs later.

ISO Tax Treatment

ISOs do come with preferential tax treatment and so are, generally, more advantageous to you as an employee... while also being more complicated! (By the way, as a sign that they are better for you, the IRS limits how much value in ISOs you can receive in any given year. You are only allowed to be granted $100,000 worth of ISOs (based on the value of the shares when granted) in any given year... any stock options you receive above this amount are treated as NSOs... even if your company calls them ISOs... yes, this is super annoying/weird!)

With ISOs, you are not responsible for any tax when you exercise your options. So, if you exercise 100 shares at $10 when the FMV is $15, you do NOT owe anything on the $500 discount, and when you sell the shares later on*, you get to pay capital gains tax (and not ordinary income). So, for example, if you end up selling when the stock hits $20 per share, you will pay capital gains tax on the difference between what you sold it at ($20) and what you paid for it ($10)... the original discount is baked in.

*In order to receive this beneficial tax treatment, you have to hold the shares for at least 2 years after receiving the grant and 1 year after exercising the shares.

Unfortunately, this is half of the story. If you hold your ISOs through the end of the calendar year, it will trigger a potential Alternative Minimum Tax (AMT) payment, as the discount element of ISOs is treated as a preference item for calculating AMT. AMT is beyond the scope of this article, but effectively it means that you can owe more money in taxes on your tax return if you exercise a certain amount of ISOs. While ultimately the AMT tax you pay turns into an AMT credit you can use in future years... that can take years, while the AMT tax is happening now!

Double-Trigger RSU Tax Treatment

Restricted Stock Units are not "options" at all. In most cases, they are the promise that you will receive company stock as long as you continue to work at the company through each vesting date. RSUs are the most common way that large public companies (Google, Amazon, Walmart, Meta, Apple, etc.) provide equity compensation to their employees (Spotify is a unique exception, as they still issue stock options to new employees). On the day that the stock vests, you receive the number of shares (usually after a certain number of shares are "held back" by the company to cover the tax withholding), and you will ultimately pay income tax on the full amount of shares that vested. If you received 25 shares at $10 per share, you will have ordinary income of $250 regardless of what you choose to do with the stock afterward. For this reason, when we're working with clients at large public companies, we frame it like this: "Imagine instead of receiving the stock, your company gave you an equivalent cash bonus and then you went out and bought $250 of your company's stock," because from a tax standpoint, that's exactly what's happening.

If you receive RSUs from a private company (which means that you can't DO anything with the stock once you receive it), they have an additional trigger beyond just being employed through the vesting date to account for this fact. The RSUs become taxable once you're vested AND once the company has a liquidity event (usually the IPO)... so you may be fully vested in your RSUs for 2 years, but until the IPO, you're not responsible for the tax liability associated with the RSUs, and there's nothing you can/should do with the shares.