What You Should Know About Stock Options and Severance Packages if You’ve Been Laid Off

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No industry was safe from coronavirus-related layoffs in 2020. And though the end of the pandemic seems to be in sight in 2021, further layoffs might still be on the horizon. Boeing announced layoffs at the end of 2020, for example, stating that it plans to eliminate 30,000 positions by the end of 2021. BNY Mellon went through rounds of layoffs in January and April 2021. Airbnb laid off 1,900 workers in 2020, and though the company has mentioned rehiring some of those people, no set plans have been released.

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In the first few days after losing a job, it’s imperative to review your finances and plan for the near future. Make sure you have enough cash in your checking or savings account for essential expenses, such as rent and groceries. As part of that calculation, include any stock options you have, severance packages, or vacation pay you might be able to recover. The sum could be substantial, but it’s also time-sensitive — so you need to act now.

Understanding Employee Stock Options

There are two different types of stock options: incentive stock options and nonqualified stock options. Make sure you know which one you have, if any.

With ISOs, you have a limited window to exercise the option and purchase employee stocks after termination — usually 90 days. If you miss that window or don’t have enough cash to exercise the options, you lose the equity.

In some cases, companies might allow you to convert ISOs to NSOs past the 90-day deadline. That makes the equity accessible for longer, but NSOs can carry a much larger tax liability than ISOs. That’s because while exercising ISOs typically does not generate a tax liability, NSOs will generate income tax at exercise. For instance, exercising 20,000 ISOs could cost nothing in income tax, but the same scenario with NSOs could come with a $300,000 tax bill, assuming you’re able to exercise shares for $25 when they are trading at $40.

Exercising ISOs is an alternative minimum tax preference item, and you might want to speak with a tax professional to avoid a tax surprise. Anyone planning to exercise stock options should carefully explore the costs and benefits upfront to determine the tax consequences of exercising stock options.

What to Do With a Severance Package

Your severance package is typically based on a number of factors: years of service, accrued vacation and sick time, and bonuses. An important part of employment benefits is health insurance. Although you can continue your current insurance coverage through COBRA, monthly premiums can cost thousands of dollars. Make sure you read through the information carefully if the company is including any COBRA premiums as part of your severance package.

Companies sometimes include accelerated vesting of stock compensation as part of the severance package. If your company accelerates vesting of restricted stock units, for example, you might owe money when filing your taxes. Companies often don’t withhold enough tax on RSUs, so make sure to budget additional tax on that income. There isn’t a strict formula for what employers include and how they calculate the resulting amount, so it’s important to investigate what it contains before you decide what to do with a severance package.

Likewise, you need to understand what obligations it carries. Severance agreements might require the beneficiary to drop any claims against their former employer, bar them from working for a competitor, or restrict what they can say. Failure to meet these mandates could result in legal and financial penalties, so it’s important to look at both the good and bad of the severance package before accepting it.

Getting laid off is emotionally scarring. Find a good friend or two who will listen to you vent, and take a few days for yourself. But don’t take too long, because some decisions are time-sensitive. The sooner you have a clear understanding of the funds at your disposal as you exit a company, the sooner you can build a realistic budget that can confidently carry you through to the next job. Remember that talent doesn’t stay unemployed for long.

About the Author

Daniel Lee, CFA, CFP®, is a financial planner dedicated to helping busy people make intelligent financial decisions by providing clear, straightforward advice free from conflict of interest. He is currently the head of Plancorp’s San Francisco office. Plancorp is a full-service wealth management company serving families in 44 states. Daniel is an award-winning instructor at UC Berkeley Extension and is a member of the CFA Society of San Francisco and the National Association of Personal Financial Advisors.