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Six employee stock plan mistakes to avoid

Understanding tax implications and your plans rules are among the keys to success.

Stock options and employee stock purchase programs can be good opportunities to help build potential
financial wealth. When managed properly, these benefits can help pay for future college expenses,
retirement, or even a vacation home.
But many investors get tripped up, dont pay attention to critical dates, and haphazardly manage their
employee stock option grants. Ultimately, they lose out on the many benefits these stock option plans can
potentially provide.
To help ensure that you maximize your stock option benefits, avoid making these six common mistakes:

Mistake #1:
Allowing in-the-money stock options to expire
A stock option grant provides an opportunity to buy a predetermined number of shares of your employers
company stock at a pre-established price, known as the exercise or strike price. Typically, there is a
vesting period ranging from one to four years, and you have up to 10 years in which to exercise your
options to buy the stock.
A stock option is considered in the money when it is trading above the original strike price. Say,
hypothetically, you have the option to buy 1,000 shares of your employers stock at $25 a share. If the
stock is currently trading at $50 a share, your options would be $25 a share in the money. If you exercised
them and immediately sold the shares at $50, youd enjoy a pretax profit of $25,000.
You may be tempted to delay exercise as long as possible in the hope that the companys stock price
continues to go up. Delaying will allow you to postpone any tax impact of the exchange, and could

increase the gains you realize if you exercise and then sell the shares. But stock option grants are a use-itor-lose it proposition, which means you must exercise your options before the end of the expiration
period. If you dont act in time, you forfeit your opportunity to exercise the option and buy the stock at
the strike price. When this happens, you could end up leaving money on the table, with no recourse.
In some cases, in-the-money options expire worthless because employees simply forget about the
deadline. In other cases, employees may plan to exercise on the last possible day, but may get distracted
and therefore fail to take necessary action.
Ask yourself how much extra value you may get by waiting until the last second to exercise your award,
and determine if thats worth the risk of letting the award expire worthless, says Carl Stegman, senior
vice president of product management for Fidelity Stock Plan Services.
Tip:
Monitor your vesting schedule, keep your contact information updated, and respond to any reminders
you receive from your employer or stock plan administrator.
Consider these factors when choosing the right time to exercise your stock options:

What are your expectations for the stock price and the stock market in general?
o If you think the stock has peaked or is likely to fall in the future, consider excercising and
selling. If you think it may continue to go up, you may want to exercise and hold the
stock, or delay exercising your options.
How much time remains until the stock option expires? If you are within 60 days of expiration, it
may be time to act.
o If you are within 60 days of expiration, it may be time to act to avoid the risk of letting
the options expire worthless.
Will you be in the same tax bracket, or a higher or lower one, when you are ready to exercise
your options?
o Taxes have the potential to eat into your returns, so you may want to exercise when you
are in the lowest tax bracket possiblethough this is just one factor to weigh in your
decision.

Mistake #2:
Failing to understand the tax consequences of ISOs
There are two kinds of stock option grants: incentive stock options (ISOs) and nonqualified stock options
(NSOs). When you receive an ISO grant, theres no immediate tax effect and you do not have to pay
regular income taxes when you exercise your options, although the value of the discount your employer
provided and the gain may be subject to alternative minimum tax. However, when you sell shares of the
stock, youll be required to pay capital gains taxes, assuming you sold the shares at a price higher than
your strike price. You must hold your shares at least one year from the date of the exercise and two years
from the grant date to qualify for the long-term capital gains rate.
If you sell ISO shares before the required holding period, this is known as a disqualifying disposition. In
such a case, the difference between the fair market value of the stock at exercise (the strike price) and the
grant priceor the entire amount of gain on the sale, if lesswill be taxed as ordinary income, and any
remaining gain is taxed as a capital gain. For most people, their ordinary income tax rate is higher than
the long-term capital gains tax rate.

Tip:
Consult with a tax advisor before you exercise options or sell company stock acquired through an
equity compensation plan.
While taxes are important, they should not be your sole consideration. You also need to consider the risk
that your companys stock price could decline from its current level. Be aware of your tax situation, but
also understand where you are in the marketplace, because there are also risks to continuing to hold the
shares, says Stegman. Know which shares are qualified for special tax treatment, what the holding
periods are, and transact accordingly.

Mistake #3:
Not knowing stock plan rules when you leave the company
When you leave your employer, whether its due to a new job, a layoff, or retirement, its important not to
leave your stock option grants behind. Under most companies stock plan rules, you will have no more
than 90 days to exercise any existing stock option grants. While you may receive a severance package that
lasts six months or more, do not confuse the terms of that package with the expiration date on your stock
option grants.
Tip:
Contact HR for details on your stock option grants before you leave your employer, or if your company
merges with another company.
If your company is acquired by a competitor or merges with another company, your vesting could be
accelerated. In some cases, you might have the opportunity to immediately exercise your options.
However, be sure to check the terms of the merger or acquisition before acting. Find out if the options
you own in your current companys stock will be converted to options to acquire shares in the new
company.

Mistake #4:
Concentrating too much of your wealth in company stock
Earning compensation in the form of company stock or options to buy company stock can be highly
lucrative, especially when you work for a company whose stock price has been rising for a long time. At
the same time, you should consider whether you have too much of your personal wealth tied to a single
stock.
Why? There are two main reasons. From an investment perspective, having your investments highly
concentrated in a single stock, rather than in a diversified portfolio, exposes you to excess volatility,
based on that one company. Moreover, when that company is also your employer, your financial wellbeing is already highly concentrated in the fortunes of that company in the form of your job, your
paycheck, and your benefits, and possibly even your retirement savings.
History, too, is littered with formerly high-flying companies that later became insolvent. When Enron
filed for bankruptcy in 1999, more than $1 billion in employee retirement savings evaporated into thin air.
More recently, Lehman Brothers employees shared a similar fate.

Consider, too, that income from your employer pays your nondiscretionary monthly bills and your health
insurance. Should your companys fortunes take a turn for the worse, you could find yourself without a
job, no health insurance, and a depleted nest egg.
Tip:
Consult with a financial advisor to develop a plan to ensure that your investments are appropriately
diversified.
Stock from an equity plan is usually a large component of an employees annual compensation, so its
easy to become overly concentrated in your employers stock, says Stegman. But you need to take a
step back, consider how these benefits fit into your long-term financial objectives, such as college
savings, retirement, or a vacation home, and develop a plan to diversify accordingly.

Mistake #5:
Ignoring your companys employee stock purchase plan
Employee Stock Purchase Plans (ESPPs) allow you to purchase your employers stock, usually at a
discount from the stocks current fair market value. These discounts typically range from 5% to 15%.
Many plans also offer a look-back option, which allows you to buy the stock based on the price on the
first or last day of the offering period, whichever is lower. If your company offers a 15% discount and the
stock rose 5% during the period, you could buy the stock at a 20% discount, already a healthy pretax gain.
Unfortunately, some employees fail to take advantage of their company's ESPP. If you are not
participating, you may want to give your ESPP a second look.
Tip:
Look at your current savings strategyincluding emergency fund and retirement savingsand
consider putting some of your savings in an ESPP. You may be able to use future raises to fund the
plan without impacting your lifestyle.
Employees often opt out of their ESPP when they are entry-level employees, says Stegman. But as
they become more established in their careers and more financially secure, they should reconsider their
ESPP. Depending on the discount your company offers, you could be passing on the opportunity to buy
your company's stock at a significant discount.

Mistake #6:
Failing to update your beneficiary information
Few people like to think about it, but its important to keep your beneficiary designations up to date. As
with your 401(k) plan or any IRAs you own, your beneficiary designation form allows you to determine
who will receive your assets when you dieoutside of your will. Its important to note, however, that if
the decedent has made no beneficiary designation, under most plan rules the executor (or administrator)
will, in fact, treat equity compensation as an asset of the decedent's estate.
Tip:
Review your beneficiaries for your equity awardsas well as your retirement accountson an annual
basis.

Each time you receive an equity award, your employer will ask you to fill out a beneficiary form. Many
grants range in life from three to ten years, during which time many factors can change in your life. For
example, if you were single when you received an option grant, you may have named a sibling as the
beneficiary. But five years later, you may be married with kids, in which case you would likely want to
change your beneficiaries to your spouse and/or children. The same holds true if you were married and
got divorced, or divorced and remarried. Its important to always update your beneficiaries.

Learn more

Understand the different types of employee compensation plans.


Read Viewpoints: "Get smart about your stock plan."

Past performance is no guarantee of future results.


Investing involves risk, including risk of loss.
Stock plan recordkeeping and administrative services are provided by Fidelity Stock Plan Services, LLC.
The tax information contained herein is general in nature, is provided for informational purposes only, and should not be
construed as legal or tax advice. Fidelity does not provide legal or tax advice. Fidelity cannot guarantee that such
information is accurate, complete, or timely. Laws of a particular state or laws that may be applicable to a particular
situation may have an impact on the applicability, accuracy, or completeness of such information. Federal and state laws
and regulations are complex and are subject to change. Changes in such laws and regulations may have a material impact
on pre- and/or after-tax investment results. Fidelity makes no warranties with regard to such information or results
obtained by its use. Fidelity disclaims any liability arising out of your use of, or any tax position taken in reliance on, such
information. Always consult an attorney or tax professional regarding your specific legal or tax situation.
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