Traditional retirement planning is grounded in the belief that if you save early and save often, you’ll accumulate enough wealth to retire with the lifestyle that you want. Most people try to achieve this feat by funneling a percentage of their paycheck into a 401(k) plan.

Unfortunately, this single strategy might not allow you to generate enough annual savings to reach your retirement savings goal.

But there is some good news: there are many other ways to amass the wealth you need to fund the retirement you want. Employee stock options provide one path to explore.

The Basics of Employee Stock Options

Employee stock options are often given as part of a compensation package to employees of a company. Options can allow you to accumulate wealth via a rising stock price.

Here’s how that works in theory: with options, you can buy shares of your company stock at a pre-determined price. If the current market price of the stock is above the pre-determined price at which you can buy the shares, the stock options are “in-the-money.”

And that means you can earn a profit from your options and start generating wealth.

If you combine “in-the-money” stock options with other assets such as a 401(k), investment accounts, or other savings or benefits like income from Social Security and pensions, you could find yourself with enough money to fully fund the exact kind of retirement lifestyle you want.

But a big question remains: how do stock options fit into your retirement plan? The answer can get complicated.

To properly incorporate the value of your stock options into your retirement plan you need to know:

  • How much of your overall wealth is tied up in company stock
  • What type of options you have
  • The best choices to make with your options now
  • Where to place the cash from the sale of any options
  • Your primary and secondary goals and objectives
  • How to minimize the potential tax impact of exercising.

Certainly, this is no easy task. But with a few simple steps, you can begin to coordinate your stock options with your overall retirement plan.

What Considerations Help Make Up a Retirement Plan

Planning for retirement should begin as early as possible. The sooner you pay attention to the ultimate goal, the sooner you can begin evaluating whether or not you’re on track. If you find you’re not, you need to adjust the goal.

One common, but incomplete, metric when tracking retirement potential is setting an arbitrary savings goal that you feel will allow you to retire once you reach it. It’s what happens when you say things like, “Once my investment portfolio reaches$1,000,000, or $2,000,000, or [enter your favorite number here], I will have enough retire. “

Sound familiar? Most people think about their retirement goal this way. But while that might give you something to shoot for, it’s not enough to build a solid plan around.

You can easily argue that having more money is better than having less money when it comes to retirement. But having more money doesn’t really answer the question of whether you have enough money to retire. At best, you’ve reach an arbitrary number that likely doesn’t address fundamental retirement planning questions like:

  • How much money do I need to live on each year?
  • What if I live longer than I expected?
  • What will inflation look like?
  • What about taxes?

This arbitrary number gets even more complicated when a significant percentage of your net worth is made up of stock options or other employer equity. As we touched on, options can be a way to grow the wealth you need to fund a retirement plan. Still, you need to be careful and manage your risk of overexposure.

To do that, you need to understand your retirement timeline.

Related: From Intern to Employee

Consider Your Timeline to Retirement

Most generally accepted investment strategies point to the fact that owning a single stock is more risky than holding many stocks. Risky in this sense means subject to greater market volatility.

Holding a significant percentage of your net worth in a single stock increases the likelihood that will be exposed to market volatility. The net result of single stock volatility may be wild swings the value of your stock options.

For example, say you set your arbitrary savings goal at $2,000,000 — and the day comes when your assets reach that $2,000,000 goal.

But what if the entire $2,000,000 is made up of a single stock position? And what if shortly after reaching your $2,000,000 goal, that stock price stock price drops 50% and the value of your options plummets from $2,000,000 to $1,000,000? How would this make you feel?

The answer might depend on how near or far you are from retirement.

If you are many years from retirement, employed, otherwise rich, or willing to take investment risk, this severe drop in value may be a non-issue. In fact, an opportunist might suggest the drop-in price is nothing more than an opportunity to buy shares on sale.

But what if this market volatility occurs in the years leading up to retirement? Or worse, right after you retire?

A significant drop in the stock price may mean a significant change in when you retire or how much you can spend in retirement. Let’s explore the impact using a simple example:

One retirement rule of thumbs says that you can withdrawal between 3-5% of your assets in retirement. If true, it’s reasonable to assume that someone with $2,000,000 can withdrawal between $60,000-$100,000 per year from their account in retirement.

If the market value of the stock options drops to $1,000,000, the same 3-5% withdrawal rule decreases your expected income to $30,000-$50,000.

This potential drop in stock price negatively impact the value of your assets and therefore your potential retirement income. That’s why considering your timeline to retirement is so important.