by Charles Steege from SFG Wealth Planning Services
Sid is considering using nonqualified stock options (NQSOs) to fund Aaron’s college costs. He has 2,000 shares that are exercisable at $50 per share. To exercise the options, Sid 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, Sid 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 savings plan.
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.
Is this strategy better than the other sources you have to fund college expenses, such as cash, stocks and bonds?
That depends. Cash flow is an important consideration, especially when college is on the horizon.
Have you mapped out your cash flow to consider the timing of compensation, tax payments and tuition payments?
What’s the right timing for exercise?
Are there better ways to fund college costs?
For example, some companies may permit you to gift NQSOs. Individuals can give a family member up to $14,000 each year (in calendar year 2015) without being subject to the federal gift tax. Check with your company administrator to determine the company’s policy on gifting stock options.
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.
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.