It may not be the first thing you think about if you’re abruptly asked to clean out your desk, but deciding what to do about your stock grants or options could have major financial implications. And the rules are neither simple nor intuitive.
“When someone loses a job, the vesting on outstanding stock options usually stops,” says Bruce Brumberg, co-founder of myStockOptions.com, which provides information about stock grants and options. “For options that are already vested, you need to know how long you have to exercise them before they’re forfeited.”
Rules vary according to the type of stock grant or stock option involved. Some companies make grants of restricted stock or of restricted stock units, or RSUs—similar to restricted stock but with important differences. Other employers provide various kinds of options, with grants sometimes linked to length of employment or to meeting performance goals, that let you buy shares at a specified price, often during a stated time window. Vesting approaches may also vary, with some shares or options vesting gradually and others all at once (known as “cliff” vesting).
In the case of restricted stock and restricted stock units (RSUs), you generally forfeit stock that hasn’t vested when you leave the company, while you get to keep shares that have already vested. However, your employment agreement or stock plan may include a provision that protects you if you’re terminated after your company is acquired by another firm.
Performance stock or options grants are typically based on whether you achieve goals during a specified period, and if you have to leave before the period ends, you’ll lose the shares even if you would have met the objective. If shares or options vest gradually, you’ll get to keep only those that have already vested. So, for example, if you’re granted options to buy 1,000 shares of company stock that have a four-year vesting schedule, with 25% vesting each year, and you’re fired after 2½ years, you’ll get to exercise the options for 500 shares. With cliff vesting, you’ll forfeit the entire grant if you leave before vesting.
If you’re forced out, it’s crucial to review the rules about grants and options as soon as possible and to exercise options, if that makes financial sense, during a post-termination exercise period that typically lasts 90 days. If you fail to meet the deadline or to adhere to any special terms of a separation agreement, your options will expire.
Finally, if you participated in an employee stock purchase plan, you get to keep shares bought for you while you were employed, but your eligibility to participate ends with your job. The company will have to return any money withheld from your paycheck to purchase shares you didn’t receive.
For many people, permanent life insurance—which includes whole and universal life policies, among others—is a good financial fit. Very often, however, a less expensive option—term life insurance—works even better. As the name implies, this type of policy provides coverage for a specific term, usually a level-premium period of 10 to 30 years (which is then often renewable to age 80 or beyond). That limitation means you pay less in premiums, though the cost advantage generally decreases as you get older.
Unlike permanent or “cash value” life insurance, which lets you build up cash value in your policy, term insurance provides only a death benefit and is often referred to as “pure” insurance. A big advantage of term insurance is its simplicity. Permanent life policies come in myriad forms, and may put the investment portion of your premium into fixed or variable investments. Fees vary widely depending on the type of policy and the riders and options you choose. Though often touted for the ability to promote saving through required premium payments, whole life and other permanent policies may be inferior to other retirement savings vehicles such as employer-sponsored plans or IRAs. In contrast, term policies are easy to understand—you make a specified payment in return for a promised death benefit.
Term insurance often appeals to those who are in the prime of their careers but who have multiple financial commitments, for mortgage payments, retirement and education savings, and other obligations. Term insurance lets such policyholders cheaply guarantee financial security for their families in the case of an untimely death.
The face amount of a term policy—its death benefit—remains the same throughout whatever number of years the policy is in force. For most level-premium policies, the insurer can’t adjust that amount, the length of the term, or the amount of the premiums. When the term expires, however, your insurance coverage ends. Many term policies guarantee you the chance to renew the insurance for an additional term, but the new premiums will be higher, reflecting your shorter life expectancy.
The cost of a particular term policy depends on your age, your health, and other factors. Typically, when you apply for a policy, you’ll have to answer detailed questions about your medical history and risk factors—policies for smokers usually cost more, for example—and you’ll have to pass a medical examination. (Some term insurance policies, approved in most states, enable you to obtain coverage without taking a physical.)
To find a term policy, you can shop online or you can work through an insurance agent. Choose a highly rated insurance company that will be around if and when your heirs need to collect on your policy.
Even if you do things the right way in estate planning, things may still turn out wrong if small details are overlooked. For instance, while you may recognize that it’s important to establish a power of attorney for an elderly relative, if the document fails to address certain contingencies, you may be powerless to act when your help is needed most.
A power of attorney, governed by state law, is a legal document allowing one person to act on another’s behalf. It must be created by someone—the principal—who has the mental capacity to understand all of its ramifications. The person appointed to act for the principal is known as the attorney-in-fact or the agent.
Once the principal has signed the document, the attorney-in-fact can make decisions for him or her.
Powers under a power of attorney may be broad or limited. For example, a broad power of attorney often grants control over all of the principal’s assets. On the other hand, a limited power might restrict an agent’s activities to selling a home or other real estate.
The most common type of power of attorney, the durable power of attorney, remains in effect should the principal become incapacitated, whereas a non-durable power of attorney is typically used for a specific purpose, such as temporarily managing a person’s financial affairs while that person is incapacitated.
While all of this may seem straightforward enough, if the power of attorney isn’t carefully drafted to accommodate changing conditions, a family’s intentions could be defeated. A common error is a document that fails to name one or more contingent attorneys-in-fact who can step in if the person named in the document is unable to fulfill the responsibilities of this position. That might happen if the original agent has died or is incapacitated or otherwise unwilling or unable to act.
To see what can go wrong, consider this hypothetical situation. John Greenbow, age 80, names his spouse Nina, age 75, as his attorney-in-fact, and their two children, Lester and Michelle, as contingent attorneys-in-fact. John creates a separate document naming himself as attorney-in-fact for Nina. Five years later, Nina shows signs of Alzheimer’s disease, so John assumes her financial affairs. But he suffers a stroke soon after and is incapacitated. While Lester and Michelle have been designated as attorneys-in-fact for John, they aren’t authorized to act on behalf of Nina.
This problem could have been easily avoided if John had incorporated language into Nina’s power of attorney that would have enabled the children to act on her behalf as well. And that’s the point—it’s crucial to think ahead and plan for the worst imaginable scenario. If you’ve anticipated all possible scenarios, you can rest easy knowing help will be there when it’s needed.
It may be better to give than to receive, but not if you’re giving results in a big bill for estate or gift taxes. Still, there are plenty of strategies for avoiding those levies. Making generous gifts now, while favorable rules are in effect, could be an especially effective way to transfer wealth to the next generation.
One way to make tax-free gifts is by using the annual gift tax exclusion. Currently, this provision in the tax code lets you avoid taxation on gifts of up to $14,000 to as many recipients as you choose. If your spouse joins you, the limit rises to $28,000.
Suppose you have two adult children and three grandchildren. If you and your spouse make gifts of the maximum amount to each of those five people, together you can give away $140,000 (5 x $28,000), completely free of gift tax. And you can continue to provide that amount year in and year out without owing taxes on the transfers.
Meanwhile, you could also help family members by paying tuition or medical expenses on their behalf without tax liability, and those payments don’t count against the annual exclusion.
By making a series of lifetime gifts, you could remove substantial assets from your taxable estate, thus reducing potential estate tax liability for your heirs. Also, if younger family members are in a lower income tax bracket than you are, this strategy may provide additional tax savings if they subsequently sell the property you give away. (One complication here is that investment income received by young children may trigger the “kiddie tax,” with much of the income taxed at parents’ rates. Even then, however, making gifts to children is likely to result in a net tax benefit.)
To further sweeten the pot, current law enables you to transfer up to $5 million of assets (indexed for inflation to $5.25 million for 2013) to family members, either through gifts during your lifetime or through a bequest in your will. This $5 million exemption, which is doubled to $10 million for married couples (indexed to $10.5 million for 2013), was preserved by the American Taxpayer Relief Act (ATRA). Unlike many previous estate tax law changes, this extension under ATRA is permanent.
There are, however, a few potential downsides to consider. First, when you give away property, you no longer have control over it, and that could be a concern if you’re putting money in the hands of those who may be too young to handle it responsibly. Moreover, using part or all of the $5 million exemption ($5.25 million in 2013) to shelter lifetime gifts reduces the amount that could be used to offset future estate taxes.
Planning for how to best transfer money to children and grandchildren can be part of your overall financial strategy. We can work with you and your tax and legal advisors to find an approach that fits your situation.
Do you own a second home in a resort area that you use personally or occasionally rent out? You could be in for a rude surprise at tax time, if the state where the home is located insists you’re a legal resident and must pay income taxes. In some cases, that may trigger hundreds of thousands of dollars of extra tax liability.
Several states, including Arizona, California, Hawaii, and New York, have been challenging the assertions of homeowners who claim to live out of state. A state may maintain that the owners actually reside within its borders, even if they consider the dwelling to be a vacation home. With other cash-strapped states taking notice of these tactics, the trend may well continue and expand.
In one high-profile case, John J. Barker, a Wall Street investment manager, and his wife argued that they were Connecticut residents who made only sporadic visits to a second home near the exclusive Hamptons area of New York. During the tax years that a New York state audit brought into question—2002 through 2004—the Barkers said the home was used by other family members. But the couple spent more than half of each of those years in New York, and the state has assessed a tax bill of more $1 million for the three years and tacked on penalties of around $220,000. The Barkers have appealed the ruling but may eventually have to pay at least part of the bill.
In another recent case, media personality Martha Stewart, too, argued that her legal residence was in Connecticut and her place in the Hamptons was just a second home. But New York prevailed and Stewart had to pay almost $222,000 in back taxes.
The Empire State has a reputation for being one of the toughest states for audits, and it often targets residents of states such as Florida, Nevada, and Texas that have no income taxes. But farmers in the heartland and jet setters up and down both coasts face similar problems. In the worst-case scenario, you could even be hit by taxes from two states on a single property. For instance, the Barkers could be liable for tax on their investment income in both New York and Connecticut (although Connecticut allows a credit against taxes paid to another state).
You may be able to avoid trouble if you clearly establish your residency in a single state of your choosing. Because residency laws vary from state to state, you’ll have to research the method for documenting your legal domicile. At the very least, obtain a driver’s license and register to vote in your home state. And be sure to keep detailed records of your whereabouts, including a summary of frequent-flier accounts, credit card receipts documenting trips between homes, and phone records that you could use to bolster a claim of residency (or of non-residency)