If you're among the 12 million Americans who receive employee stock options, you may be counting on them to help you retire in style. They can, as long as you pay close attention to the tricky rules that govern them. "Employee stock options are complex, and it's easy to make mistakes at retirement that can have catastrophic results," warns Maureen Kerrigan, a manager at Deloitte & Touche in Washington.
The most basic rule is not to get greedy. Christopher Cordaro, a Chatham (N.J.) financial planner, points to clients who are executives in their 50s at Lucent Technologies. In early 2000, when Lucent's shares were trading above $70, these executives' options were worth millions--and some planned to retire within a year. Cordaro says he advised them to start cashing out--but they didn't. "They kept holding out for a higher stock price, and when the price instead fell, they continued to do nothing, waiting for a rebound," he says. Today, with Lucent shares trading around $7, the clients' options are practically worthless and retirement a far-off dream.
If you plan to retire within the next 12 months, start exercising options in which you have profits. Your financial needs should dictate how much you exercise, not your projection of where the stock is going. "If your options are worth $2 million and you need $1 million of that for a comfortable retirement, then cash in the $1 million," says Cordaro. Sure, you may kick yourself if the stock surges within the next couple of months. But as long as you have the money you need to realize your goals, that's all that matters.
Your strategy will also depend on how long you have once you retire to exercise your options. Employees who remain at a company usually have 10 years to exercise options. But that period is typically shortened to 90 days when you depart. Be sure to ask at the office. Some companies give retirees less than 3 months to exercise, while others give them two to five years.
Also key is whether you have incentive, or qualified, stock options--which are largely granted to top executives--or nonqualified stock options, which are more typically awarded. When you exercise the nonqualified kind, you immediately owe income taxes on your profit, regardless of whether you keep or sell the underlying stock. When you exercise incentive stock options, however, taxes aren't due until you sell the underlying shares. If you hold that stock for more than a year before selling, you pay taxes on profits at the often lower capital-gains rate.
TRICKY. If you have nonqualified options and must exercise them within 90 days after retirement, consider a December departure, says Michael Beriss, a financial adviser with American Express in Bethesda, Md. That way, you can exercise your options in the next tax year, when you are likely to be in a lower income tax bracket. And if you have incentive stock options, you may want to cash them in within 90 days even if your company gives you more time. That's because under tax law, incentive stock options turn into nonqualified options 90 days after retirement.
There's one more trick. If you live in a state with an income tax and plan to retire to a state that has none, you may be able to lower your tax bill by timing your options exercise to the move. State tax laws vary widely on this point. So it's best to seek the advice of a financial planner or tax attorney to see if you can take advantage of that move.
Stock options can provide a cushy retirement. The key is to start cashing them in while they still have value--or risk finding one day that they have none. By Susan Scherreik