Employee stock options can be a great perk. Even a life-changing one. But the multiple variables at play make it hard to know if and when to exercise your options.
Your stock options give you the right to exercise, but you’re never obligated to do so. Assuming you stay employed at the company, you can exercise your options at any time between when they vest and when they expire — typically, this will span up to 10 years. If you’re leaving your employer, check the fine print in your options contract to see what time frame you have to exercise; this is usually referred to as the “post-termination exercise period.”
You’ll need to consider multiple factors before deciding when to exercise your options within the 10-year window. Here are four major considerations to get you started. But keep in mind, seeking a second opinion from a financial advisor who understands equity compensation can help ensure you’re considering all the factors of your particular situation.
ADAdvertisement
Get matched to a financial advisor for free with NerdWallet Advisors Match.Match With an Advisor for free
ADAdvertisement
Get matched to a financial advisor for free with NerdWallet Advisors Match.Get Matched for Free
ADAdvertisement1. Whether your options have value
It only makes sense to exercise your options if they have value. If the strike price (or exercise price) of your stock options is lower than the market price of your company shares trading on the exchange, they have value.
In this case, you could exercise your options, purchasing company shares at a below-market price. Then you could turn around and sell those shares on the stock market and pocket the difference — known as the “bargain element.”
Alternatively, if you believe in your company’s future prospects, you may want to hold onto your options. If your company’s share price rises, your options’ worth will continue to grow while putting off any tax consequences. The longer time frame could give your options even more value.
What you’ll need before you exercise
Gather any information related to your stock options so you can make strategic decisions about which to exercise and when. You may find the details in your equity documents. If you need help, contact your company’s human resources department or your equity platform. At a minimum, you need to know:
- The type of stock options you were granted — incentive stock options (ISOs), nonqualified stock options (NSOs) or a mix of the two. The difference matters for how they’re taxed.
- The grant date, vesting date and expiration date of each option grant.
- How many company shares you’re eligible to purchase.
- What price you’ll pay per share (the strike price, also known as the exercise price).
2. Whether your company is public or private
It makes a difference if your company is publicly traded or privately owned. The considerations in a private company can be trickier.
- Shares aren’t traded on the stock exchange, so you’ll need to pay out of pocket to exercise and fund the purchase (instead of being able to sell shares and cover your cost).
- You’ll take on the risk of holding illiquid shares that could take a long time before an initial public offering or other liquidity event occurs for you to cash out.
If your company is private and files for an IPO, it could be good timing to consider exercising your incentive stock options. That’s because ISOs are subject to a holding period of one year post exercise — and two years post grant — in order to qualify for favorable tax treatment. And companies headed toward an IPO have naturally waiting periods that you could take advantage of.
- Once a company files for an IPO, it generally takes several months to prepare before the actual listing.
- Immediately upon listing, company insiders (including employees) are typically subject to a lock-up period where they are restricted from selling shares. This often lasts six months, but the rules vary by company.
By exercising your options at the time of filing, you may satisfy the holding period requirements by the time you’re allowed to sell shares.
» Learn more: How much tax you’ll pay on IPO stock
3. Whether it makes sense from a tax perspective
The type of stock options you own impacts how — and when — you’ll be taxed. The tax rules quickly become complicated (see our stock options tax guide for details), so consider working with a tax professional who can help you model possible scenarios in light of your full financial picture. Here are key things to know when it comes to timing your exercise.
- NSOs (and ISOs sold before meeting holding requirements) are taxed at ordinary income tax rates in the year you exercise. To avoid getting pushed into a higher income tax bracket, you could consider exercising options in a low-income year or in batches over a few years.
- ISOs that meet the tax-related holding requirements aren’t taxed when you exercise. But the bargain element could trigger alternative minimum tax, which parallels the standard federal tax system. Your tax liability gets calculated under both systems simultaneously, and you pay whichever tax bill is higher.
- Any gains the shares experience after you exercise would be treated as capital gains. You may owe short- or long-term capital gain taxes, depending on how long you held the shares.
Tax tip: There are numerous ways to manage — or avoid — an AMT tax bill. One way involves exercising ISOs early in a calendar year, says Steve Moyer, a certified financial planner and certified equity professional with Mariner, a wealth management firm. That way, you would meet the holding requirements early the following year and could sell shares to cover your AMT bill before Tax Day. “But we benefited from the tax savings,” Moyer says.
4. Whether it fits with your financial situation
With many financial decisions, the best time to do something is when it works for you and your goals. You may be financially ready to exercise if:
- You understand the mechanics of exercising and have modeled the tax implications, so you’re not surprised come tax time.
- You have cash on hand to buy the shares and cover a potentially large tax bill (or a plan for selling shares to do so).
- You know whether you’ll hold or sell shares, and how you’ll use the proceeds to fund your other financial goals and diversify your portfolio.
One of those goals may be diversification. If your company shares become an outsized contributor to your net worth, you may be overly exposed to a single stock. You may want to sell the shares so you can use those proceeds to diversify your portfolio.
If you have all your plans in place but the value of your shares hasn’t met your expectations, being in a strong financial position may make it easier to wait. For example, if your income covers all of your expenses — or if you have deferred compensation coming in for a few years — you may be able to put off exercising your options until later.
If you need an infusion of cash for some other purpose — perhaps to start a business, fund education or purchase a home — you may decide the timing (and not the value of your options) is most important. In that case, it’s still critical to have a thorough and strategic plan so that you can hold onto as much of the value of your stock options as possible.
What's your financial need?
Financial Planning
Retirement Planning
Investment Management
Tax Strategy
Other
ADAdvertisement
Should you exercise early?
Your company may allow you to exercise employee stock options early, prior to vesting. This means you would pay to purchase company shares before the shares officially become yours and can be sold.
Paying for shares before they’re yours may seem counterintuitive, and it comes with additional risk: The shares may never reach the value that you want.
So, why would you consider it? Exercising early starts the holding period clock for ISOs to qualify for favorable tax treatment. And early exercise could shrink your tax bill. If you’re able to exercise when the strike price is close to the market price, you’ll have less income to report, you may pay less tax now than you would if the shares appreciated further.
If you exercise early, you’ll need to file an 83(b) election to ask the IRS to recognize your income at this point in time. It’s due within 30 days of vesting.
Explore more on
