Learn What Happens to Stock Options when You Resign, Retire, or are Terminated from Your Company.
Stock options help companies retain and reward employees. They can give you a stake in the company’s success and may be an important part of your compensation package. In fact, 31% of employers offer employee stock options to improve compensation.
However, many employees do not know what happens to them when they leave. Whether you are facing a layoff, resigning, or retiring, knowing what to do afterward can be challenging.
In this guide, we will explain the types, what to do, and how to prepare. Together, these elements will help you to understand employee stock options.
Understanding the Types of Employee Stock Options
A stock option allows you to buy a specific number of shares at a set price, also known as the strike price. These come with a vesting schedule. This means you must remain with your employer for a specific period before you can exercise them. There are two types.
Incentive Stock Options (ISO): These are tax-advantaged options that have favorable capital gains treatment when certain conditions are met.
Non-Qualified Stock Options (NSO): These options have greater flexibility. However, they are treated as ordinary income when you exercise them.
Vested Versus Unvested
The first thing you want to do is find out whether your options are vested or unvested.
Vested: Vested options are what you keep for a limited time after you leave the company.
Unvested: Unvested options are immediately surrendered when you leave your employer.
Typically, resigning before the options are vested means you will lose them. However, some companies offer accelerated vesting in the event of an acquisition or layoff.
What Happens to Vested Options When You Leave?
Vested options give you a window to exercise them after leaving your employer. This window typically lasts 30 to 90 days, though it may be longer depending on your employer’s policies. If you fail to exercise them within this window, these options will expire worthless. This is regardless of whether the underlying stock has increased in value.
For instance, you have 1,000 vested options at a strike price of $30, and the stock is trading at $70. If you fail to exercise them within the deadline, you might leave $40,000 in gains on the table.
We recommend checking your employer’s stock options agreement for all post-termination guidelines.
Understanding What Happens to Your Options When You Quit
ISOs have much stricter rules that you need to understand. You generally have 90 days to keep the tax-advantaged status for these options. After that, these options automatically convert into NSOs, which are taxed differently.
We recommend that you consider the tax implications before exercising your ISOs. If you are near the end of the calendar year, you could be subject to the Alternative Minimum Tax (AMT).
The AMT is a parallel tax system that ensures high-income earners pay a minimum amount in taxes. It can affect certain tax deductions and adjustments in the income tax calculation. The result is that they may pay the AMT even if they would not otherwise do so.
Special Situations
How you depart from your employer will directly impact how your stock options are treated.
Early Retirement or Layoffs: In these situations, many companies will give you accelerated vesting or a longer exercise window. This is typically included in your severance package.
Termination for Cause: If you are terminated for cause, you will lose all rights to vested and non-vested options.
Acquisitions and Mergers: In these situations, your options can be cashed out, converted into the acquiring company’s shares, or terminated. The terms of the deal between your employer and the acquiring company spell out what happens to them.
We recommend that you study your employer’s equity agreement to understand what will happen with your options.
How to Be Prepared?
The best way to be prepared is to follow these steps before quitting or accepting another job offer.
- Study the vesting schedule and stock option grant agreement.
- Ask Human Resources about the exercise window and your alternatives if you leave.
- Visit with a tax advisor if you plan on exercising your options or own ISOs.
- Move fast, as any delays could cause you to forfeit your options.
Options can be a powerful tool for wealth creation. Understanding the rules and how they apply to your situation is the key to unlocking their potential.
The Bottom Line
Leaving your employer can be a life-changing decision. Knowing what happens to employee stock options when you leave a company could help you protect what you earned.
The best approach is to ask questions, read all agreements, and plan your next move prudently. The steps you take now could make the difference between walking away with a significant nest egg or nothing.