A lot of people may be given shares in their employer’s stock or may have the opportunity to buy their employer’s stock at a discounted rate (or at least with no trading costs). Although startups and certain industries may present an excellent opportunity to build up wealth, in the majority of situations we think it is more prudent to hold shares in your employer’s stock only long enough for the shares to vest and to minimize the tax impact.
What kinds of situations are we discussing?
- We are discussing stock in publicly traded companies only. Some privately held companies offer shares based on private valuations and all we’ll say is be weary.
- Some employers will grant their employees shares or stock options that vest over a set schedule of time. For this article, we’ll assume any shares or options have vested by the time you’re trying to make a decision.
- Other employers will offer employees the ability to purchase stock at a discount (often 10-25%), or they’ll do some sort of stock match. Frequently, the trading fees will be waved, making this an easy investment. It makes a lot of sense to participate in these programs as you have a guaranteed return.
Why Should I Hold the Stock Through the Vesting Period?
Because otherwise, you may get nothing or will be giving up free money! If your employer-contributed shares have a vesting period, you’ll want to hold any shares as long as necessary to get the full benefit of those shares.
Why Should I Seek To Offload My Company Stock?
- Dreams of hitting it big and sailing away on a yacht are nice, but disciplined investors know slow-and-steady (usually) wins the race.
- Investing too heavily in any one investment is inherently risky. Though the rewards may prove phenomenal (we all wish we could have invested in Microsoft or Apple decades ago), investments in broad-based or S&P 500 indexes haven’t been too shabby either over the long-term.
- You’re already probably dependent on your employer for your day-to-day living expenses. Why would you want to put all your eggs in one basket and be dependent on your employer for your savings/retirement/emergency funds? If the company goes under you’ll be out of luck (so this advise applies to allocating 401(k) funds to your employer’s stock as well!). If this sounds like fear mongering, ENRON’s collapse was not that long ago.
What is this Tax Issue You’re Talking About?
- If your employer’s stock price goes up from the time you bought your shares, and the shares are not in some sort of tax-advantaged account (like a 401(k)), you will have capital gains.
- At the risk of oversimplifying, if you’ve held the stock for less than a year, you’ll then have short-term capital gains that are taxed as ordinary income. If you’ve held the stock for more than a year, you’ll have long-term capital gains taxed at the capital gains rate, which is usually lower than your ordinary income tax rate.
- It will typically be wise to hold on to your investment for at least one year if it has increased in value to avoid paying more in taxes (unless you foresee significant upcoming losses).
- For a more detailed discussion on long-term vs. short-term capital gains, see this article.
If My Employer’s Stock Price Goes Down, Is There A Benefit to Holding the Shares For One Year?
As far as we can tell, no. Short-term capital losses and long-term capital losses are apparently taxed the same. So, if your employer’s stock has a bad day, that can be a great time to cash in, collect the benefit of an employer match, and move your money into a diversified index in a Roth-IRA or other investment. It may also present you with the opportunity to offset future short-term capital gains (and thus gives you more flexibility down-the-road).
When Should I Hold My Employer’s Stock Beyond the Vesting/Tax-Minimizing Time Frame?
It’s perfectly understandable to want to hold on to some shares in your employer. After all, you work for there, you’re helping build the business, and you probably know more about this investment than any other. We propose that each time you make the decision whether to sell or hold your shares, all of the following criteria continue to be met:
- You have a strong belief in the viability of the business and its products/services;
- You have faith in the company’s management team and their vision;
- You’re not financially dependent on this investment (and you’re not totally financially dependent on your job);
- You have realistic expectations about the future value of this investment; and
- A significant portion of your wealth is in more diversified assets.