One of the challenges of navigating a layoff is preparing for the severance conversation, which typically arrives on short notice and involves a number of decisions that can have long-lasting implications. How will you receive your final payout? What will be included? And what happens with your other benefits?
Any equity compensation you may hold, however, warrants some specific preparation, in part because it can be worth more than the severance payment itself over time. It also tends to come with the tightest deadlines and the least flexibility once the agreement is signed. Your severance conversation may be one of the few times when the terms of your equity are still open for discussion, so it is worth going in with a plan.1
Start by taking inventory
Before you can ask for anything, you need a clear picture of what you hold. Many people have equity spread across several grants, plan types, and vesting schedules, and it is easy to lose track of the details.
Pull out your grant agreements and your equity plan documentation, then list each award that you hold:
- Unvested restricted stock units (RSUs) and their next vesting dates2
- Vested and unvested stock options, noting whether each grant is an incentive stock option (ISO) or a nonqualified stock option (NSO)
- Shares purchased through an employee stock purchase plan (ESPP)3
- Performance shares or other award that were given to you based on individual or company results
- Any deferred compensation balances and their payout schedules
Confirm your official termination date with HR and your plan administrator. That date often determines what vests, what is forfeited, and when your exercise window starts. Your equity plan document will typically outline how each type of holding is treated after a layoff, and on what schedule, and should be your source of truth given that every company’s approach to the process can be different.
Know your baseline
Your severance agreement will dictate exactly which rules apply to your situation, but there are some general standards that most companies follow when it comes to the default treatment of equity compensation holdings.
RSUs and options: Unvested holdings are usually forfeited on your termination date. Vested RSUs at a public company are generally yours to keep, but private company RSUs may also need a liquidity event, such as an IPO or acquisition, before they have any value you can use.
Vested stock options: These typically come with a post-termination exercise window, often 90 days. If you do not exercise within that window, the options may expire worthless.
Incentive stock options: In order to keep their favorable tax treatment, these generally must be exercised within three months of leaving the company. After that, they are treated as nonqualified options for tax purposes.
Employee stock purchase plan: ESPP contributions usually stop at termination and, depending on the plan, unused contributions may be refunded or used for a final purchase.
The IRS covers how stock options and other types of equity compensation are treated for tax purposes in great detail on its own website.4
What you can ask for
Not every company will be open to changes to your severance package, and public companies in particular might face plan rules or board approval requirements that limit what HR can realistically offer. Still, equity terms are often more flexible than people expect, and it never hurts to ask.
Requests that are worth considering include:
- Accelerated vesting: Ask whether some or all of your unvested equity can vest at separation. Even a partial acceleration, such as the next scheduled tranche, can make a meaningful difference in your overall benefit.
- An extended exercise window: More time to exercise vested options can give you room to plan, raise cash, and manage taxes. Keep in mind that incentive stock options exercised more than three months after you leave will generally be taxed as nonqualified options, so a longer window can involve a tradeoff.
- Recalculation of performance awards: If you receive equity awards on a periodic basis that are tied to results, ask whether a prorated portion can be paid out or remain eligible to vest.
- A later separation date: This can be a tricky area, but if your vesting date is close, a short extension of your employment, sometimes through a paid notice or transition period, may allow another tranche to vest.
- Clarity in writing: Whatever you agree to, make sure the severance agreement outlines and explains it clearly, including dates, share counts, and how each award will be treated.
Weigh the tax picture before you sign
Equity decisions and tax decisions are closely linked, and the timing of a severance package can change the math.
Exercising options takes cash, and it can create a tax bill even if you do not sell the shares. For nonqualified options, the difference between the exercise price and the market value is generally taxed as ordinary income at exercise. For incentive stock options, that difference is not taxed as regular income at exercise, but it may trigger the alternative minimum tax.
Also remember that severance pay is taxable as income, and in the year of a layoff it can combine with equity events to push you into a higher tax bracket than usual. Depending on when your payments land, a lump sum paid in December and one paid in January could fall in different tax years. A tax projection before you sign can help you see how each option might play out and which requests are worth the most to you. This is where coordinated tax planning can help.
Bring your advisor into the conversation
Many people wait until after the agreement is signed to talk with their advisor. But, by then, the most useful window for negotiation has usually closed.
By consulting with them before you sign, your advisor can help by:
- Modeling what each piece of the package may be worth after taxes
- Comparing scenarios such as exercising now versus later or selling versus holding
- Looking at how much of your net worth would remain concentrated in your former employer's stock
An employment attorney can review the legal terms of the agreement, including any release of claims or new restrictions. Your advisor can coordinate with your attorney and your tax professional so each decision supports the others. Many workers also have a review period before the agreement becomes binding, often 21 days or longer for workers 40 and older5, which can give you time to bring everyone together.
Learn more about how we approach financial planning and advisory with our clients.
Your next steps
Whether a severance conversation has recently landed on your calendar, or if you have an agreement in hand, the time is now to take inventory of your equity compensation holdings, confirm your deadlines, and gather your plan documents.
If you would like help working through your options, talk to a Composition Wealth advisor. We would welcome the chance to look at your equity with you and plan what comes next together.
Composition Wealth, LLC (“Composition Wealth”) is a registered investment adviser. Advisory services are offered only to clients or prospective clients where Composition Wealth and its representatives are properly licensed or exempt from licensure. This communication is for informational purposes only and should not be considered investment, financial, tax, or legal advice. Please consult your own tax, legal and accounting advisors before making any related decisions.
Composition Wealth and its affiliates do not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.