By Chuck Steege. Justin, a mid-level operations executive, pops into Carol’s office one day. Justin is seeking advice from the company’s long-time stock plan administrator about tapping funds for his son’s college tuition next fall. While Justin has several options for meeting college costs for his son, Aaron, he’s trying to understand the net after-tax proceeds if he used options to fund tuition costs.
Justin is considering using his 2,000 shares of nonqualified stock options (NQSOs) that are exercisable at $50 per share. Carol walks him through the math to exercise the options. To satisfy the exercise, Justin can pay cash, swap employer stock he owns, or exercise and sell in a “cashless exercise,” netting the difference. The stock value is now $100 per share. At that rate, Justin will have to pay the company $100,000 on the exercise date, which will leave him $100,000. After taxes, he will net approximately $60,000 for Aaron’s college expenses once he enrolls.
The income tax liability for exercising the NQSOs will be based on the difference between the stock value and the exercise price. Any gain from NQSOs is taxed as ordinary income, as shown below.
Once Carol explains the impact of taxes and the proceeds from the sale, she sends Justin on his way with additional questions to consider with a financial advisor before he makes his decision:
Is this strategy better than the other sources he has to fund college expenses, such as cash, stocks and bonds?
Should he map out his cash flow to consider the timing of compensation, tax payments and tuition payments?
When is the best time to exercise?
Is there a better source of funds from which to fund college expenses?
NQSOs are one of many sources for financing a college education. Should he exercise now or wait until the options are ready to expire? A careful analysis is needed to determine when the stock options have reached their full potential.
It is important to analyze the timing, sources of funds and tax impact of various approaches to college funding. Justin’s consultation with Carol helped to quantify net proceeds from the exercise and identify a series of questions to consider next. Creating a college funding plan will help Justin carve out college funds to ensure there are no surprises when Aaron’s tuition bill comes due.
As specialists in executive compensation, tax and financial planning, SFG Wealth Planning Services, Inc. can assist your participants in optimizing personal financial planning around the timing of these options.
Mr. Steege is President of SFG Wealth Planning Services, Inc., SFG Investment Advisors, Inc. (SFG), a fee-only financial planning firm. Founded in 1993, SFG is dedicated to assisting senior executives and their employees with their complex stock-based compensation and planning challenges.