A growing number of companies figure employees will perform better if they have something to gain.
About 28 million American employees own stock in the company they work for, according to a survey by the National Center for Employee Ownership.
Such stock ownership comes in several forms, ranging from stock purchase plans to 401(k) plans to broadly granted stock options.
Stock option plans were once used just to reward top management and other key players. But more and more companies are using stock option plans to reward – and retain – a wide range of workers. In the last 25 years, the number of people holding stock options has increased about nine-fold, according to the National Center for Employee Ownership.
A stock option isn’t an award of stock. A stock option simply gives the employee the right to buy a certain number of shares at a fixed price for a certain number of years.
You may be given an option to buy company stock at $5 a share – called the grant price — anytime over the next 10 years. The idea is that you can quickly profit by buying the stock – exercising your option – and selling it, usually the same day. If not the same hour.
Some options are phased in. For example, your company may grant you a total of 1,500 shares — 300 shares a year over five years. Many companies won’t allow you to exercise your stock options until you’ve worked there a certain period of time.
So, when do you want to exercise your stock options?
Many people wait until just before the option expires — assuming the market price is higher than the grant price. You may also want to exercise your option if the value of the stock represents more than 10-20 percent of your net worth. You don’t want all your eggs in one basket.
The tax consequences of exercising your stock options can be complicated. In some circumstances, your profits are taxed at the capital gains rate. In other circumstances, the profits are taxed at the higher rates levied on ordinary income.