Group Term Life Insurance vs. Individual Coverage: What’s the Right Move?

Group Term Life Insurance vs. Individual Coverage: What’s the Right Move?

In our work with young families, one of the first layers of their financial landscape we assess is life insurance. For most people, there are two ways to put this critical protection in place: through your job’s benefits via group term life insurance and/or on your own with an individual term policy. 

Each avenue differs in a handful of ways. There’s often a clear winner in terms of getting the right mix of protection and value. But it may not always be what you expect… 

In short, your group term life insurance may not offer enough coverage. And even if it provides the needed death benefit, you may be able to save money by getting a policy elsewhere.

So let’s break it down here.

What is Group Term Life Insurance?

Group term life insurance is coverage that is made available to you through your employer, as part of a benefits package. Further, it’s broken into a couple different flavors: basic and supplemental. 

Basic Group Life Insurance

  • It comes at no cost to you, since the employer covers the premium.
  • It is guaranteed-issue (no health screening).
  • Generally, it offers a smaller coverage amount, such as $50k or up to a minimal factor of your salary (like 1.5x salary).
  • The premium amount on the first $50k of coverage paid for by your employer is not treated as taxable income to you. However, any premium amount paid for by your employer on a death benefit in excess of $50k is considered taxable income to you, even though you never receive the cash. This is called “imputed income”.

Here are a couple examples of how this coverage is detailed in a benefits packet:

group term life insurance
group term life insurance

Supplemental (Voluntary) Life Insurance Through the Employer

  • You are fully responsible for the premiums on this coverage.
  • The coverage may be guaranteed up to a certain coverage amount.
  • Additional coverage may be available beyond the guaranteed benefit (up to a stated max) contingent on medical underwriting, though the health screening is often “lighter” than when applying for personal coverage.
  • The premium is simply deducted from your paycheck on an after-tax basis.
  • The coverage is issued with “group rates”, meaning the cost is based on a large risk pool.

Again, here are a couple examples of how this may appear in a benefits packet:

group term life insurance
group term life insurance

Is Group Life Insurance Enough Coverage?

Maybe. Probably not.

Mike goes into depth on several key aspects of life insurance in this blog post, covering: how much to get, when to get it, what type to get, and mistakes to avoid, among others. So I’ll quickly hit a few high points here.

For starters, if someone depends on your income, both now and in the future, it’s worth protecting. AKA, you need life insurance. As far as how much is enough, we have this life insurance calculator you can use to arrive at a true coverage need based on your wishes.

As with anything, life insurance is a personal decision, one that depends heavily on your unique situation, goals, and values. Generally, families want to provide coverage for some combination of:

  • Income replacement
  • Debt
  • Education expenses

The right coverage means that your family’s desired lifestyle and future goals continue to be a reality, even in a worst-case scenario. In many cases, group life insurance won’t offer a benefit high enough to provide full coverage.

Is Group Term Life Insurance a Good Value?

Maybe. Sometimes no.

Even if you could get enough coverage through your employer, it still pays to thoroughly examine the cost of that policy.

Life insurance premiums are based on two main factors: your age and health. In some cases, your health may even disqualify you from getting coverage altogether, outside of a guaranteed-issue policy.

If You Have Health Conditions

A major benefit of group life insurance through your employer is that some amount of coverage will be issued on a guaranteed basis, requiring no “evidence of insurability”. For those who wouldn’t otherwise qualify for life insurance, this is significant. 

Remember that the “basic” coverage amount will be guaranteed. Then, if supplemental coverage is an option, a portion of that is typically also offered as guaranteed-issue. In the example below, any amount over $700k requires a health screening (evidence of insurability). But that means you could still secure up to $700k in death benefit without answering a single health question.

So if this is your only way to get access to coverage, there’s no way to beat the value of getting something vs. nothing.

group term life insurance

If You Are Healthy

Keep in mind that rates for group coverage are based on a large health pool. Essentially, the “average” person. If you’re in good health, it may behoove you to capitalize on that by applying for coverage through a personal policy. There’s a good chance you’d pay less per amount of coverage compared to a group policy through your job, since you’d land a more favorable health rating.

I almost always see this work out in favor of the healthy individual. If that’s you, your group policy may very well NOT be a good value. Look to get the coverage through a personal policy.

Watch Out for Increasing Premiums

Commonly, the premium for supplemental coverage through an employer will increase over time, based on your age. This could mean a very affordable cost while you’re younger. But that can shift quickly as you get older. Check out an example of this in the screenshot below.

Alternatively, it’s possible to obtain a “level premium” term policy when doing so outside of your employer. This means the cost is set for the duration of the policy. Over the course of 10-30 years, this could mean substantial savings if you qualify for a good health rating with a personal policy, even if the group policy is relatively cheaper at the start.

group term life insurance

In short, if you’re healthy, you’ll likely find more value by securing an individual life insurance policy. If you don’t otherwise qualify for coverage, take advantage of all the guaranteed benefit you can through the employer.

Important! If you are going to replace an existing supplemental group policy with an individual one, be sure you’ve paid for and locked in any new outside coverage before dropping the voluntary policy with your job. It’s best to avoid gaps in coverage.

What Happens to Group Life Insurance If You Leave Your Job?

Oftentimes, group coverage is not “portable”. If you separate from your job for any reason, it may not go with you. That’s a big deal, given that life insurance is a major layer of risk protection for your family. We can’t always predict employment separation, since it could include being laid off or fired. It’s not just a planned retirement or quitting. For that reason, we often recommend excluding any employer-based life insurance coverage amount when calculating your need.

If coverage is portable, it will be the supplemental amount (not basic coverage). You need to check with your employer to determine whether or not the policy is portable. Also, know that the rate would likely be different after leaving.

The Complete Group vs. Personal Coverage Comparison Workflow

Here are the steps you should take to navigate this process:

  1. Take what’s given to you for free through your employer (basic coverage).
  2. Determine your true coverage need.
  3. Compare the cost of getting that coverage between a supplemental group policy vs. an individual policy.
    • Once you know how much benefit you need in place, get quotes for an individual policy through an insurance broker.
    • Apply for a policy through the carrier that offers you the best rate and complete any underwriting requirements. You’ll never know your actual cost until you receive a health rating from the insurance carrier, which requires a completed application.
    • If you are denied coverage, then the guaranteed-issue amount of group supplemental coverage is your only way to get meaningful protection.
    • If you receive a low health rating, the supplemental coverage will likely be a better value for you. Then, you’ll need to assess the cost/benefit of paying a relatively higher premium to secure full coverage beyond what the employer policy provides (paying mind to the portability of group coverage).
    • If you land a strong health rating, you will most certainly be in a position where putting an individual policy in force makes the most sense, with no need to pay for supplemental group term life.

A Final Note on Shopping for Coverage

When you go searching for life insurance coverage, we recommend using a broker, rather than an agent who represents only one insurance company. This way, you can compare quotes across several different carriers and increase your chances of getting the most competitive rate for a policy.

While we don’t sell any products at Upbeat Wealth, we do walk through this entire process with our families. In doing so, we can be an objective sounding board to ensure the most appropriate coverage for their unique situation is acquired. No decisions are made alone.

Frequently Asked Questions About Group Term vs. Individual Life Insurance

Q1: Is group term life insurance enough coverage?

In most cases, no. Employer-provided group life insurance typically offers limited coverage (often 1–2x salary), which is usually not sufficient to fully replace income, cover debts, and fund long-term goals like education.

Q2: What is the difference between group and individual life insurance?

Group life insurance is provided through an employer and often has limited coverage and flexibility. A portion of it may be fully paid for by the employer (basic), with the option to purchase more coverage (supplemental). Individual life insurance is a personal policy that you own, totally separate from your employer, with customizable coverage and typically level premiums.

Q3: Is supplemental life insurance through an employer worth it?

It depends on your health and alternatives. If you have health conditions, supplemental coverage can be valuable due to a certain benefit amount being guaranteed issue. If you’re healthy, an individual policy is often more cost-effective over the long-term.

Q4: Do you lose group life insurance when you leave your job?

Sometimes. In many cases, group life insurance is not portable. If it is portable, it’s usually only the supplemental portion and the premiums may change after leaving your employer.

Q5: Why is group life insurance sometimes more expensive over time?

Group policies often have increasing premiums based on age, while individual term policies can lock in a level premium for 10–30 years, making them more predictable and often cheaper long term for healthier individuals.

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Fiduciary, fee-only, Certified Financial Planner, Eddy Jurgielewicz

Eddy Jurgielewicz, CFP® is a Partner and Lead Financial Planner at Upbeat Wealth, a fee-only firm based in New Orleans and serving clients virtually across the country. He specializes in providing straightforward financial guidance to ambitious young families as they navigate life’s many milestones.

Do you have questions about what we shared in this post, or anything else in general? Feel free to schedule a free consultation or drop us a line!

Sign up for our newsletter (at the bottom of this page) to stay up to speed on our Upbeat Insight.

Disclaimer: All content in this article is provided for educational, general information, and illustration purposes only. None of the information is intended as investment, tax, accounting, or legal advice. Nor is it a recommendation for purchase or sale of any security, or investment advisory services. We encourage you to consult with a financial planner, accountant, and/or legal professional for advice on your specific situation. Read our full disclaimer here.

The Risk of Holding Too Much Cash & What to Do About It

The risk of holding too much cash

Too Much Cash?!

Yes, it’s possible.

Much like any time I sit down with a spoon and a pint of Ben & Jerry’s, the same holds true with cash… You can, in fact, have too much of a good thing. When it comes to the ice cream, I always do. When it comes to your cash, we want to help you avoid “overindulging”. 

Of course, cash has its benefits:

  • Security
  • Financial flexibility
  • Easy access to your money

Even so, there’s a very real tradeoff. What you gain in safety, you give up in potential growth and progress toward longer-term goals.

Risk #1: Inflation

As we all know too well, stuff gets more expensive over time – except, of course, for the Costco hot dog. One dollar today doesn’t buy what it did 20 years ago. This is the handiwork of inflation. It erodes the real value of money through the years, reducing your “purchasing power”.

The graph below shows year-over-year inflation during the last decade.

12-month percent change in CPI-U over the last 10 years

Source: https://www.bls.gov/ 

Even now, with inflation cooling, prices were 2.4% higher in February of this year relative to February 2025. 

If your dollars aren’t growing at a rate that outpaces inflation, you are losing money in terms of actual spending capacity. An account balance of $100k 30 years from now won’t do nearly as much for you as it would today.

In fact, going off inflation data for the last 30 years, it would do about HALF as much! To buy the equivalent amount of goods and services with $100k in 1996, you’d need $211k today (based on this CPI calculator).

Thanks, largely in part, to the post-COVID spike, the average annual inflation rate over the 10-year period between the start of 2016 and end of 2025 was 3.2%. The Federal Reserve has a target inflation rate of 2%. So even in “the best of times” prices are still expected to go up.

Cash vs. Inflation, an Example

Let’s take a look at what inflation would have done to even a relatively favorable cash position over the last 10 years.

The State Street SPDR Bloomberg 1-3 Month T-Bill ETF (BIL), as the name indicates, invests in Treasury bills with maturities of 1-3 months. Because T-bills are issued by the US government, they’re considered to be nearly risk-free and are a “cash alternative”. 

We’ll match that up to the overall US stock market, using the Vanguard Total Stock Market Index ETF (VTI). Specifically, we’ll view the performance of these two funds for the 10-year period from 1/1/2016 to 12/31/2025.

Assuming that dividends were reinvested, the overall return for each of these funds during the stated period was:

  • BIL: 2.04%
  • VTI: 14.25%

Here’s what that looked like:

VTI vs. BIL Nominal

Source: https://totalrealreturns.com/

If you were in search of safety for your money, BIL would have done well preserving your capital while earning some interest. $10,000 would have grown to $12,236.59. This is roughly what your cash would have done had it been sitting in a high-yield savings account during that stretch.

However, there’s one (now hopefully obvious) flaw here. The 2.04% overall return is before accounting for inflation. The returns above are what we call “nominal”. When we adjust for inflation, we work with what’s called the “real” return. 

So here’s how those funds compare over the last 10 years with inflation (CPI-U) baked in…

Real Return

  • BIL: -1.12%
  • VTI: 10.71% 
VTI vs. BIL Real Return

Source: https://totalrealreturns.com/

In terms of what your money could actually do for you, it would have lost value if left in BIL for 10 years.

If that same $10,000 was collecting dust in a checking account or traditional savings account, earning 0% to 0.05%?? Forget about it.

Risk #2: Longevity

At this juncture, some people out there may wonder, “What’s so bad about losing just ~1% over 10 years? At least my money wasn’t subject to big swings in the market. In the end, I barely lost any purchasing power.”

Well, sure. But it’s a simple fact: the longer you want (or need) your money to support your lifestyle, the more of it you need to have. So the growth rate of your assets over time directly contributes to the length of the runway you build up for yourself.

This isn’t to say you should go full throttle on the most aggressive investments you can get your hands on. There’s a wonderful world that exists between the extremes. But it underscores the importance of taking a risk-appropriate approach to growing your wealth so that you set yourself up for the best chance of success in realizing your ideal future state. 

What is the RIGHT Amount of Cash to Hold?

To determine the “right” amount of cash…

  1. Calculate your Emergency Fund need
  2. Evaluate any short-term goals (new car, vacation, home project, etc.)
  3. Add these together and voila!

We recommend keeping these funds tucked away in a high-yield savings account. To take it one step further, we favor using an option like Ally that allows you to create “buckets” within a single account. That way, you can easily categorize the savings and always know exactly what each dollar is set aside for.

And bear in mind, the point of this cash is NOT to be a growth engine in your plan. Rather, it DOES…

  • Cover you when something inconvenient inevitably occurs
  • Help prevent the need for taking on higher-interest debts (credit card balances)
  • Allow for quick and easy access
  • Avoid market losses

OK, Now What?

Once you’ve established the optimal cash balance to keep on hand, it’s time to create a plan for the rest. One benefit of getting clear on your cash need is that it frees you up to take on more risk (appropriately) with other resources, creating more efficiency all around. Having adequate cash set aside increases your plan’s risk capacity. In other words, with your bases covered, you are in a position to handle greater risk in the accounts geared toward your long-term goals.

In short, that “extra” cash is ready to be invested. 

Similar to what you did above, ask yourself: What is the purpose of these surplus funds? What will they ideally do for you? Additionally, consider the anticipated timeline before you expect to access them.

Addressing these points will guide what type of investment account those resources go into and how much risk you can reasonably take on when they get to work. For example, money tagged to help support your retirement at age 60 makes sense going into a Roth IRA, where it might be allocated to 100% equities. Funds that will be used to help with a down payment 6 years from now are not as well-suited in an IRA, nor should they be invested so aggressively. Those will serve you better in a taxable brokerage account, with a more conservative approach.

Cash plays a critical role in your financial plan. Yet, it pays to understand its limits and what to do if you can identify any excess. 

Frequently Asked Questions for Cash

Q1: How much cash is too much to keep in savings?

You may be holding too much cash if you’ve already set aside enough for your emergency fund and any short-term goals, but still have a large amount sitting in checking or savings with no clear purpose. Cash is useful for flexibility and protection, but too much of it can quietly slow your long-term progress if it isn’t keeping up with inflation.

Q2: Why is holding too much cash a problem?

The biggest issue is that cash often loses purchasing power over time because of inflation. Even if your account balance stays the same, or grows a little, the real value of that money can decline if prices rise faster than your interest rate. Over long periods, that can create a meaningful drag on your financial plan.

Q3: Is cash losing value because of inflation?

Yes. Inflation reduces what your dollars can buy over time. That means money sitting in cash may feel “safe,” but if it isn’t earning enough to outpace rising prices, it is losing real value in the background. This is one of the main reasons excess cash can become costly over the long run.

Q4: Where should I keep my emergency fund?

Your emergency fund should usually stay somewhere safe, liquid, and easy to access—typically a high-yield savings account. The goal is not maximizing return. The goal is making sure the money is available when you need it, without taking market risk.

Q5: Should I invest money instead of leaving it in cash?

If the money is not needed for emergencies or short-term goals, investing may make more sense than leaving it idle in cash. The best place for that money depends on its purpose and timeline. Money needed soon should generally stay conservative, while money for long-term goals like retirement can usually tolerate more investment risk.

Q6: Is a high-yield savings account enough to beat inflation?

Not likely. A high-yield savings account can help reduce inflation drag compared with a traditional checking or savings account, but it won’t consistently outpace inflation over long periods. It can be a great tool for cash reserves, but it usually shouldn’t be your primary strategy for long-term wealth building.

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Fiduciary, fee-only, Certified Financial Planner, Eddy Jurgielewicz

Eddy Jurgielewicz, CFP® is a Partner and Lead Financial Planner at Upbeat Wealth, a fee-only firm based in New Orleans and serving clients virtually across the country. He specializes in providing straightforward financial guidance to ambitious young families as they navigate life’s many milestones.

Do you have questions about what we shared in this post, or anything else in general? Feel free to schedule a free consultation or drop us a line!

Sign up for our newsletter (at the bottom of this page) to stay up to speed on our Upbeat Insight.

Disclaimer: All content in this article is provided for educational, general information, and illustration purposes only. None of the information is intended as investment, tax, accounting, or legal advice. Nor is it a recommendation for purchase or sale of any security, or investment advisory services. We encourage you to consult with a financial planner, accountant, and/or legal professional for advice on your specific situation. Read our full disclaimer here.

What is Enough?

What is enough?

What is "enough"?

There’s nothing like a major life milestone to bring on a spell of deep reflection. Since having our daughter a few months ago, I’ve really been chewing on the question of, “What is enough?”

I’ve been asking myself questions such as:

  • What do I need in order to feel fulfilled in my day-to-day life?
  • What are the experiences that fill my cup?
  • How do I want to allocate my time?
  • What is it that I value most?
  • What does this look like today? Next year? 20 years from now?

Sorry, folks, but this one might leave you with more questions than answers (not that I claim to have all that many to start with). Maybe that’s the point?

Enough is elusive

It’s at the core of any real financial planning endeavor. Yet it has a way of eluding many of us. If we are fortunate enough to fully wrap our minds around the concept one day, it’s likely to shapeshift and escape our grasp not long thereafter, leaving us searching once again for an accurate description of what breeds true contentment in our lives.

It’s almost never a simple question to answer. It makes sense, though. Life is far from linear. People evolve. Circumstances change. 

Then there’s the fact that it’s different for everyone. No one can tell me what enough is in my life, just as I can’t tell anyone else what enough is in theirs. Though, as a financial planner, I get to have a lot of fun with gently nudging people to find their answer.

Is enough a number?

I think not.

At least, it’s not the best place to start. Sure, a number is necessary to punch into a financial plan. We need to have that data point as a goal to shoot for, so we know how to build our resources up to it. But what is it that the dollar figure represents? What does it do? What is the significance? What will that money be in service of?

Because the reality is this: a number, alone, is void of any meaning. 

A common “enough” question revolves around the idea of retirement. Most people we work with ask some version of the question, “How much money do I need to stop working for a paycheck one day?” 

I just typed into Google, “How much money do I need to retire?”, and the AI Overview told me:

“A common benchmark is to save 10–12 times your final annual salary or aim for a portfolio that allows you to withdraw 4% annually. For many, this means a total nest egg between $1 million and $1.5 million, though this varies heavily based on location (e.g., $700k–$2.2M+ in the US) and lifestyle.”

Great! In reality, this largely tells me nothing. Obviously, blanket guidance is rarely all that helpful in specific scenarios. But this is a stark example of that. Sure, it’s better to build up $1 million than $0. Nonetheless, the numbers provided are empty. As would be my response if I attempted to answer a person’s “how much do I need” question before doing the real work of learning what truly matters to them.

The point is, I can’t begin to tell someone how much money they need if I don’t yet know what that money is meant to be in service of. Life is not purely numbers. 

This is why, at Upbeat Wealth, our initial planning process includes an entire meeting dedicated to learning about the values of the family we’re working with before we begin offering recommendations.

How do you know when you have enough?

You don’t usually get in the car without knowing where you’re driving to. Unless, of course, you’re an angsty 17-year old Eddy in his ‘96 Crown Vic, blasting The Eagles, windows down, going wherever the road would take him, finding peace in nothing more than the warm southern summer wind and that freedom that only a few bucks of gas can buy… Ok, digression done. You can’t make it to a destination unless you have one to begin with.

Here’s the thing, though: money, on its own, makes a terrible goal. Winning the lottery, getting a big inheritance, landing that promotion, finishing first in your high-stakes fantasy football league… None of those are sufficient if you haven’t done the real work first. You have to first understand what purpose the money will serve in your life.

Ok, now you might be thinking something like, “I’d sure feel like it was enough if I was making triple my current income!” (and not gonna lie, that does sound nice). Still there’s a ton of research out there that remains generally mixed. 

An older study from 2010 by Daniel Kahneman indicated that emotional well-being increased as income rose to $75,000 and then basically flatlined from there. In 2021, Matthew Killngsworth refuted this and determined that well-being did rise with income even as it exceeded the $75k mark. Interestingly, hold the phone, the adversarial dynamic duo later teamed up in 2023 and found a more nuanced result. They saw that, generally, higher incomes were associated with higher levels of well-being for many people. However, for people classified as “unhappy”, higher incomes did little to improve their overall level of happiness.

My takeaway is probably overly simple, but I can’t see a way around it: “Happy” people have figured out how to align their resources with what’s important in their lives. If you’re “unhappy”, more money, alone, is not a magic bullet. And if you’re “happy”, having more money increases your ability to fill your life with even more of what brings you satisfaction.

Someone might earn what’s considered a “good” salary. At the same time, if that income isn’t used intentionally to align with the person’s values, it is essentially worthless. It comes and goes. 

You could have millions set aside. Yet, what is that money really worth if you don’t have a clear definition of what enough is in your life? 

Don’t skip the critical first step: Get clear on what’s important to you and your life. Find your destination.

To answer the question, my best guess for how you really know when you have enough… I wager it’s more of a feeling than anything you can put your finger on.

If your money could talk, what story would you want it to tell?

Here’s a thought exercise I’ve been toying with… I personify money and ask the question: “At the end of my life, what will you have done for me over the years?”

What story would I want Money to tell me in response?

Immediately, I know I wouldn’t want Money’s first words to be anything like: 

  • “I grew to such-and-such balance across all of your accounts”… 
  • Or, “I compounded at an average annual rate of x% over your lifetime”…
  • Or, “Y% of me was allocated to tax-advantaged and tax-free accounts”… 

There’s no emotion in any of that. It sounds a little empty.

Because it’s not about Money. Money is simply a facilitator. It’s the outcome that matters, the life that’s lived.

I would hope to hear something raw. Something with teeth to it. Something that moves me. I’d want Money to tell me a tale that makes me smile. The kind of smile that grows deep inside and extends to every corner of my heart. It’s a story I’d yearn to hear time and time again. That story is beyond the scope of this post…

If you put Money in the hot seat, what would you hope to hear?

So what is enough for me now?

My current version looks something like:

  • Spending time with my wife and daughter
  • Seeing a smile on their faces
  • Supporting my wife’s dreams and ambitions
  • Raising my daughter to see the best in herself and be a positive force in the world
  • Sharing time with our loved ones and friends
  • Experiencing new places, cultures, and ways of life
  • Getting outside into nature on a regular basis
  • Prioritizing my physical and mental health through an active lifestyle
  • Having flexibility in how I distribute energy between my family and my business
  • Serving client families that inspire me
  • Being generous with my time and resources so that I can have a positive impact on others in my community

That list right there. That’s my north star. Or as we call it here at Upbeat Wealth, my Statement of Financial Purpose. It’s an ever-changing work in progress, and that’s ok with me because I want it to always represent what’s most important to me in the moment.

If I’m doing it right, my money – my financial plan – will only ever be enough if it facilitates those things above.

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Fiduciary, fee-only, Certified Financial Planner, Eddy Jurgielewicz

Eddy Jurgielewicz, CFP® is a Partner and Lead Financial Planner at Upbeat Wealth, a fee-only firm based in New Orleans and serving clients virtually across the country. He specializes in providing straightforward financial guidance to ambitious young families as they navigate life’s many milestones.

Do you have questions about what we shared in this post, or anything else in general? Feel free to schedule a free consultation or drop us a line!

Sign up for our newsletter (at the bottom of this page) to stay up to speed on our Upbeat Insight.

Disclaimer: All content in this article is provided for educational, general information, and illustration purposes only. None of the information is intended as investment, tax, accounting, or legal advice. Nor is it a recommendation for purchase or sale of any security, or investment advisory services. We encourage you to consult with a financial planner, accountant, and/or legal professional for advice on your specific situation. Read our full disclaimer here.

Financial Checklist for Expecting Parents: What We Did by Trimester

Financial Checklist for Expecting Parents

The Key Financial Planning Decisions We Made When Expecting

Are you planning to grow your family, or already expecting the newest addition? If so, I hope this post serves as a helpful tool for navigating the mostly financial (and some not-so-financial) baby preparation checklist.

I’ll break down exactly what my wife and I did by trimester, but keep in mind that your situation might mean doing things differently.

A general word of advice...

If you have a partner through this journey, work together as a team as much as possible. Communicate. Give yourselves grace. Key into when one of you may need to step up and take the lead on a task, so the other can step back and focus on themselves.

Before I give context to each step, here’s the overview of exactly what we did:

First Trimester

  • Chose a provider and where we wanted to give birth
  • Reviewed our health insurance and the estimated costs of pregnancy + birth
  • Looked over our other employee benefits
  • Created new savings buckets and cash goals
  • Reviewed our monthly household cash flow
  • Assessed our life insurance coverage and made necessary increases
  • Mapped out a plan for leave
  • Began looking into options for childcare and other support

Second Trimester

  • Made and shared the registry
  • Put the baby’s room together

Third Trimester

  • Got our estate plan done
  • Made final purchases of baby supplies

Fourth Trimester

  • Obtained our baby’s birth certificate and Social Security card
  • Added the baby to our health insurance
  • Reviewed the hospital bills
  • Updated our estate plan
  • Opened a 529
  • Made a note for the child tax credit
  • Took necessary steps to open a Trump Account

While we put some intention behind the order of things, you could certainly switch it up. We also wanted to front-load the pregnancy with these financial tasks to leave space for more unexpected life things that might come up as the pregnancy progressed.

The First Trimester

Choose Your Provider and Where You Want to Give Birth

For us, this was fairly easy. My wife’s sister had recently given birth to her second baby, having had a great experience with her OB-GYN and the hospital. This was enough for my wife to feel comfortable following suit. Still, we needed to confirm that the provider was in-network. Fortunately, she was.

Review Your Health Insurance and Estimated Costs

We knew there would be plenty of surprises to come. If we could help it, we didn’t want the cost of birth to be one of them.

My wife spent a healthy amount of time on the phone with various representatives for our health insurance company, over the course of multiple calls, investigating the specifics of costs and coverages for pregnancy and birth-related care.

To be safe, we made a plan to proactively save an amount equal to our out-of-pocket maximum in a dedicated cash bucket. That way, if we encountered something unexpected, we’d still have the funds available to take care of the bill.

Mike gets into everything you need to know about evaluating health insurance while pregnant in this previous blog post.

Look Over Your Other Employee Benefits

Beyond health insurance, there are some other employee benefits that can be especially valuable when expecting a baby. We sat down to review exactly what else we had access to through my wife’s employer (that’s where our family gets our benefits).

Getting pregnant, while an incredibly fortunate and life-changing milestone, is not a “qualifying life event” that allows you to make changes to your benefits outside of the standard open enrollment. But if you pass through an enrollment window for your job (or even switch jobs, giving you an initial benefits enrollment period) while expecting, this is a great opportunity to make any impactful updates. Otherwise, birth is the next chance you’ll get to make adjustments (more on this below).

Create New Savings Buckets and Cash Goals

Hello, Ally (we love their bucketing system for organizing cash)!

There were 3 new cash buckets we wanted to add to the mix:

  • Medical Expenses
  • Doula
  • Baby Supplies

As I mentioned, we wanted to set aside enough cash to cover our OOPM for a potential “worst case” scenario. That went into the “Medical Expenses” bucket. Once we knew how much a doula would cost, we put money aside here to have ready. Then, we set a target of $2,000 for the “Baby Supplies” bucket to cover up-front costs. The idea was that this would cover things like a stroller, car seat, bassinet, etc… anything we thought we’d need ready for when baby came home (emphasis on thought, because I’m telling you… you just can’t fully know until you’re in it).

A word of advice: Based on your baby and how you choose to operate, you will likely find there are new or different things you need after you bring your little one home. We were quick to pivot on some things, or introduce new gadgets to make our lives any bit more manageable in those first weeks. So leave some cash on hand in the “Baby Supplies” bucket for those early postpartum days. You. Will. Need. It.

Review Your Household Cash Flow

Obviously, a new child doesn’t merely come with a one-time setup cost… there’s ongoing maintenance involved. We wanted to make sure we were managing our expenses in a way that we could absorb the increased month-to-month outflows that a new family member creates. When you get to this point, consider things like how you plan to feed (will you have expenses like bottles and/or formula early on?) and how soon you expect to incorporate paid childcare.

This exercise also helped inform us on how we could meet the up-front cash savings goals mentioned above, since we still had time to build those up.

Assess Your Life Insurance Coverage & Increase if Needed

As your family grows, life insurance cannot be overlooked. The bottom line is this: if someone depends on your ability to earn an income, you need appropriate protection in place. 

There’s a reason I include this as an action item in the first trimester. Pregnancy-related health complications, like high blood pressure or gestational diabetes, for which women are at a greater risk in the second and third trimesters, could potentially cause coverage to be denied. In other cases, the insurer may delay the application process until after the baby is born, or they’ll issue a policy with a lower health rating (meaning higher premiums). 

In short, your health matters. So it’s especially important for birthing mothers to handle this as early as possible to have the best chance of a policy being issued and earning an optimal health rating. Non-birthing parents shouldn’t delay either. Your age contributes to the premium as well!

Even if you’re planning to stay at home for an extended period of time, your family will benefit from you having coverage too. While you may not be earning a salary during that time, it goes without saying that you do provide a wealth of support. If something were to happen, that benefit could allow the surviving parent to take some time away from work with your child, search for a different job that provides greater flexibility of time, cover the added expenses to keep the household together, and more.

Here’s a previous blog post with a helpful explainer on all things life insurance. And this is a calculator we use with our families to help them determine an appropriate amount of life insurance to put in force.

Map Out a Plan for Leave

Parental leave plays a big role in the finances of a baby. How much do you have? Is it fully paid? Can you tap into a state-paid family leave system? Do you and your partner stagger leave to extend the amount of time before needing additional support or paid childcare?

It’s somewhat of a guessing game, especially this early on, since you can’t know exactly what the due date will be. But we wanted to have a draft plan in place as soon as possible so that we could generally know what to expect in terms of other support and childcare.

Begin to Plan for Childcare and Other Support

Even if you don’t know for certain whether you’ll be fortunate enough to have family support, seek out a nanny, put your child in daycare, or do some combination of these, I recommend learning the cost of everything in your area. It’s very location-dependent! Getting on this as early as possible also helps increase the chances you get into the daycare of your choice, if that’s the direction you go. It’s not crazy for wait lists to be several months.

The Second Trimester

Make and Share the Registry

If you’re like us, you’re lucky enough to have already received a random assortment of hand-me-downs and loaned items at this point. This is about the time we sat down to take inventory of what we’d been given and what we thought we’d still need.

After hours of research and interviewing friends with babies, we built out our registry and began sharing it with family + anyone else who was generous enough to ask for it.

Put the Baby Room Together

It didn’t feel totally real in the first trimester. But my type A-ish personality wouldn’t let us get past the second trimester without getting the baby’s room set up. We learned much more about the supplies and such we’d need as the nursery came along. So taking care of this sooner allowed us to have those realizations with less concern that time was ticking down too quickly.

The Third Trimester

Get Your Estate Plan Done

This had been on my mind since getting married earlier in the year, and a baby on the way was just the motivation I needed to get this across the finish line.

With the help of an online DIY-type estate planning platform, we worked through the big decisions… beneficiaries, guardian roles, powers of attorney, healthcare agents, end-of-life wishes, and so on. 

In the end, we drew up the following documents:

  • Financial Powers of Attorney
  • Health Care Powers of Attorney
  • Medical Directives (living wills)
  • Wills

We plan to set up a trust as well, which is on our to-do list for the current year…

If you’re looking for a helpful primer on the various estate planning documents and the important roles they play in your family’s life, start by reading this blog post.

Make any Final Purchases

In the final weeks, we filled in any gaps from the registry and hand-me-downs. I have to plug Facebook Marketplace and local “Buy Nothing” groups here. With resources like these, you really don’t have to spend a small fortune on all that baby stuff, unlike what the baby industrial complex might have you believe (unless that’s your thing, which is cool too).

The Fourth Trimester (yes, this is a thing)

Get the Birth Certificate and Social Security Card

After marking the baby, these two documents are a top priority as you navigate those first few dizzying days. In our case, the hospital had a person responsible for grabbing one of us for a few minutes to fill out the necessary forms. They then handled mailing them off to the proper destinations and provided the next steps for us to complete at home. I couldn’t see straight to know if my spelling was correct, so it was a pleasant surprise when the documents came back with our baby’s name spelled the way we wanted. 

Add Baby to Your Health Insurance

As I mentioned above, birth is a qualifying life event, so this is the precious window where you want to get your newest family member added to your health insurance. Employers will give you 30 days (or more, in some cases) to get this done. 

For us, this meant notifying my wife’s HR department and our insurance company. We had to send in a copy of our daughter’s birth certificate and provide her Social Security number, so it’s helpful to be on top of getting these promptly.

Review the Hospital Bills

This part was anxiety-inducing, even though we’d prepared for the worst-case scenario. Be on the lookout for those bills. And don’t worry, they know how to find you. Review them carefully and know that you have some options. If you feel inclined to do so, negotiating your bill can possibly save you some money. Also, many healthcare providers will offer generous payment plans that could include 0% interest. 

Update Your Estate Plan, If Needed

Now that our daughter had been born, there were a couple of things we wanted to adjust in our plan. Don’t let any updates to your plan slip through the cracks!

Open a 529

Since we wanted to get money to work for college quickly, we opened a 529 as soon as our daughter had a Social Security Number. This is all you’ll need to get the account open (on top of the basic stuff like name and address).

Check out Mike’s college savings blog post for a more in-depth look at how we think about planning for education costs.

If you want to be creative and open a 529 sooner… You could start one before your child is even here and designate yourself as the beneficiary (if you don’t already have one). Start funding it whenever you want. Then, after your baby arrives, simply change the beneficiary of the account from you to them. 529s allow for a beneficiary change to a “qualified family member” at any time without taxes or penalty. Your child counts as one such qualifying family member.

Make a Note for the Child Tax Credit

The IRS gives a $2,200 tax credit for each child under age 17. Up to $1,700 of this is refundable. Both of these amounts are the same for tax years 2025 and 2026. 

So if you welcomed a new child in 2025, you could get a larger refund (or owe less money) come tax time this year. Moving forward, you can also decide whether or not you want your W4 to reflect the child tax credit.

Including the child tax credit on your W4 generally results in a higher paycheck throughout the year and less, or no refund at tax time (get your money when you earn it). By not notating the credit on your W4, you’ll get a smaller paycheck throughout the year and may get a larger refund.

And don’t forget that other dependents – those aged 17-18, full-time college students ages 19-23, or older dependents – can be claimed for a nonrefundable credit of up to $500 each.

Make a Note or Take Action to Open a Trump Account

Since our daughter was born in 2025, she’s eligible to receive $1,000 from the Treasury Department toward a Trump Account in her name. We don’t plan to add any additional funds, but we’re happy to accept the free money! 

To sign up, the IRS has a new document: Form 4547, which you can file with your 2025 tax return, indicating that you’d like an account to be opened. Our CPA included a checkbox on his intake form for our 2025 taxes to make sure this gets included with the return.

There’s also an online portal that should allow for enrollment this coming summer.

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Fiduciary, fee-only, Certified Financial Planner, Eddy Jurgielewicz

Eddy Jurgielewicz, CFP® is a Partner and Lead Financial Planner at Upbeat Wealth, a fee-only firm based in New Orleans and serving clients virtually across the country. He specializes in providing straightforward financial guidance to ambitious young families as they navigate life’s many milestones.

Do you have questions about what we shared in this post, or anything else in general? Feel free to schedule a free consultation or drop us a line!

Sign up for our newsletter (at the bottom of this page) to stay up to speed on our Upbeat Insight.

Disclaimer: All content in this article is provided for educational, general information, and illustration purposes only. None of the information is intended as investment, tax, accounting, or legal advice. Nor is it a recommendation for purchase or sale of any security, or investment advisory services. We encourage you to consult with a financial planner, accountant, and/or legal professional for advice on your specific situation. Read our full disclaimer here.

Year-End Tax Planning: Smart Moves to Save You Money

Year-End Tax Planning Smart Moves to Save You Money

Ever feel like the holiday season is too quiet? Maybe not enough going on? Boring, even?

Well, I have a little gift for you. It’s the perfect time to add some year-end tax planning to your life!

And for a few reasons...

  • As the year comes to a close, you have a pretty good idea of what your actual income will look like, along with other variables that impact your tax outcome.
  • With the new year just around the corner, you likely have a sense of how things will look in comparison to the one that’s closing out.
  • Occasionally, in years such as this, there is new legislation that creates opportunities and/or hurdles to consider from one year to the next.

Here are 7 end-of-year tax planning strategies to consider as 12/31 approaches:

  1. Compare your total estimated tax bill to your actual taxes paid
  2. Top off tax-advantaged investment accounts
  3. Optimize 529s for state income tax deductions or credits
  4. Explore opportunities for tax-loss harvesting
  5. Consider tax-gain harvesting
  6. Assess the potential for Roth conversions
  7. Maximize your charitable donation strategy

Compare Your Total Estimated Tax Bill to Your Actual Taxes Paid Before December 31st

For starters, it’s helpful to have a heads-up on where you stand with Uncle Sam. Have you overpaid, putting you on pace for a large refund? Have you not paid enough to the IRS, potentially even exposing yourself to an underpayment penalty? Not only do we want to eliminate surprises, but also allow for enough time to make some final adjustments before the year closes. 

Most people – as employees of a company – have money automatically taken out of their paychecks to cover federal taxes and state taxes. But simply having it withheld doesn’t mean it’s the right amount, especially if you have other types of income aside from your salary. Other individuals, such as business owners, those with large amounts of investment income, or people with supplemental income like RSUs, may be making quarterly estimated tax payments. But again, as things shift throughout the year, it’s necessary to confirm you’ve been paying an appropriate amount.

End-of-year projections can be very powerful

Here at Upbeat Wealth, we run tax projections for all of our planning clients toward the end of the year to assess where they stand with the IRS. If you want to give it a shot on your own, check out the IRS’s tax withholding estimator tool.

At a minimum, you’ll want to be sure you’re going to cross over the Safe Harbor threshold

If you don’t give the IRS enough of your total tax liability during the calendar year, they will assess an underpayment penalty. The key here is that the IRS likes to get its taxes when the income is earned. To avoid a penalty, the IRS (and states) have the Safe Harbor rule for determining the minimum you need to pay. You won’t be penalized if you meet at least one of the following:

  • Owe less than $1,000 in tax for the current year.
  • Pay at least 90% of the total tax bill for the current year.
  • Pay at least 100% of the tax you owed for the previous year. This bumps up to 110% of the previous year’s tax bill for those with an AGI over $150k (over $75k if married filing separately).

Making sure you’re in the clear with this rule can protect you from paying any extra amount to the IRS in the form of penalties.

Top Off Tax-Advantaged Investment Accounts

Now is a great time to see how you’re doing with contributions to certain investment accounts that have a December 31st deadline for the tax year. These include:

  • Employee contributions to workplace retirement plans, such as a 401k, 403b, etc.
  • Health Savings Account (to make the contributions via payroll deductions, which allows you to avoid FICA taxes on the amount contributed)

These accounts have a maximum annual contribution limit set by the IRS (which is typically adjusted every year or two). If you’re not already on a path to hit that amount, consider adjusting your payroll deferral percentage to direct surplus cash flow into any of these accounts you have access to so you can get there by year’s end.

What are the annual IRS contribution limits?

  • 2025 Max for 401ks and 403bs
    • $23,500
    • + $7,500 for age 50+ ($31,000 total)
    • + $11,250 for ages 60-63 ($34,750 total)
  • 2025 Max for HSAs
    • Self-Only: $4,300 (+ $1,000 for age 55+)
    • Family: $8,550 (+ $1,000 per eligible spouse age 55+)

On a separate note, keep an eye on the balance in any Flexible Spending Accounts since these are of the “use-it-or-lose-it” variety. 

Optimize 529s for State Income Tax Deductions or Credits

If you’re saving into a 529 for your child’s education, or plan to, take a close look at your home state’s tax rules. Over 30 states offer either an income tax deduction or credit for contributions made to a 529 if it’s established through their own program. The available benefits are different from state to state.

Explore Opportunities for Tax-Loss Harvesting

If you have any losses in a taxable brokerage account, you can benefit from “capturing” (or harvesting) those investment losses. By selling a position that is in the red, you “realize” that loss (considered “unrealized” until a sale occurs) and can use it to offset other investment gains you may have realized during the year. If you don’t have any gains to knock down (or if your losses exceed your gains), you can use up to $3,000 of investment losses ($1,500 if filing MFS) to reduce your ordinary income for the year, carrying any remaining losses into future years for use.

Example:

Let’s say Marcus sold “investment X” earlier in the year for a gain of $5,000.

At the end of the year, he sells “investment Y” and realizes a loss of $12,000.

When preparing his taxes, he can use his $12k in losses to “offset” his $5k in gains. This results in a net $0 of investment gains for the year, thus no taxes on that investment income.

Now, he still has $7k of unused losses. He can use $3k of that to reduce his income for the year. Finally, he has $4k in losses that will carry forward to the next tax year.

The Finer Details

When doing the math, you have to first net short-term capital losses against short-term capital gains. Then, separately do the same with long-term capital losses and long-term capital gains. Next, you net those two amounts against each other (if you have a gain/loss for each).

At tax time, Form 8949 and Schedule D are used to report your capital gains and/or losses.

Be careful with the Wash Sale Rule

What the rule says: If you buy the same investment, or a “substantially identical” security, within a 30-day window before or after selling it at a loss, then that loss is disallowed. That means you miss out on the tax benefit. In other words, you cannot use that loss to reduce other investment gains or income. An important note is that the rule applies across all accounts that both you and your spouse own, if you’re married.

Crypto is different

Notably, the wash sale rule does not apply to cryptocurrency. Therefore, you could sell a cryptocurrency at a loss and then immediately repurchase it that same day while still being able to use that captured loss against other gains or income.

Consider Tax-Gain Harvesting

If your income is relatively lower this year compared to others (think: sabbatical, time between jobs, back in school, etc.), and you’ve moved down to a lower long-term capital gains tax bracket, then you may have a nice opportunity to sell appreciated taxable investments and pay taxes at a lower rate.

Did you know? In 2025, if your income is under $48,350 (single) or $96,700 (MFJ), you are in the 0% long-term capital gains tax bracket. Meaning you’d have the chance to sell some investments with a gain at a 0% tax rate!

2025 Long-Term Capital Gains Brackets

  • Single Filers
    • 0%: ≤ $48,350
    • 15%: $48,351 – $533,400
    • 20%: > $533,400
  • Married Filing Jointly
    • 0%: ≤ $96,700
    • 15%: $96,701 – $600,050
    • 20%: > $600,050

Assess the Potential for Roth Conversions

Do you have money in a pre-tax retirement account that you’d like to move over to a Roth? If so, there are a couple of times where doing so can make even more sense from a tax standpoint:

  • When you’re in a relatively lower-income year
  • When the stock market is down

Here’s another case where a lower-income year may bring some opportunity. In this case, you’ll want to focus on your ordinary income tax bracket, since this is what’s applied to any amounts converted from a pre-tax retirement account to a Roth. If you do find yourself in this position, you could consider taking advantage of any room left in that relatively lower tax bracket to pay less taxes on the conversion than you would in more “typical” years.

And if the stock market is down, resulting in a lower balance in the account, there’s simply less income produced in the process of converting, compared to when the account balance is higher. In other words, it makes the tax on the conversion cheaper.

If you plan on executing a Roth conversion, make sure you have the cash on hand to pay the tax bill.

Maximize Your Charitable Donation Strategy

If charitable giving is part of your routine, then it pays to examine your strategy through a tax lens as we near year’s end, especially in 2025. In particular, the passage of the OBBBA over the summer came with a handful of specific updates impacting how you should think about charitable donations. Let’s look at each here:

The standard deduction for this tax year is $15,750 (single) and $31,500 (MFJ).

  • Therefore, your total itemized deductions (which can include donations to charity) would need to exceed those levels in order for itemizing to save on taxes. 
  • If your typical single-year donation amount doesn’t move the needle on your total itemized deductions above the standard amount, then “bunching” might be worth exploring. This involves combining the amount you would normally donate across multiple years into a single one.

The cap for the state and local tax (SALT) deduction was raised from $10,000 to $40,000 (though it phases out for those with a MAGI of $500k and goes back down to $10k when MAGI hits $600k).

  • So for those with higher state and local taxes, that can much more easily push you into itemizing territory when adding in charitable contributions.

Beginning in 2026, you’ll only be able to deduct contributions that surpass 0.5% of your Adjusted Gross Income (AGI).

  • This means the same contribution will count for less on your taxes in 2026 than it will this year.
  • This is another reason for some filers to consider the “bunching” approach mentioned above. More specifically, moving what you’d normally donate in 2026 forward into 2025 and combining it with this year’s annual giving could easily produce a better tax outcome.

Also starting in 2026, itemized deductions will be capped at 35% for those in the 37% marginal bracket.

  • Therefore, charitable donations will be slightly less impactful from a tax standpoint for those in the top bracket after this year.
  • Yet another reason for those in the highest bracket to bunch into 2025.

For those who don’t itemize, starting in 2026, you will be able to deduct up to $1k (single) and $2k (MFJ) for donations directly to charity.

  • If your typical donation amount doesn’t move the needle with itemizing over taking the standard deduction, and you haven’t yet completed your giving for 2025, consider delaying to January. 
  • If you don’t itemize, you can take a deduction in 2026 that you wouldn’t get this year.

Lastly, here’s a general refresher on how to make the most of charitable donations, including the details on donating appreciated investments to a donor-advised fund, another fantastic tax-planning move!

Year-End Tax Planning FAQ

Q1: Why is tax planning so important at the end of the year?

The end of the calendar year is when you have the most complete picture of your income, deductions, credits, investment performance, and so on. You should also have a general idea of what those same variables will look like in the coming year for comparison. This allows you to make the most tax-informed decisions within your financial plan. 

Q2: What is year-end tax planning?

Year-end tax planning is the process of running projections and making adjustments before December 31st to reduce your current tax bill and avoid surprises at filing time.

Q3: Which accounts have a funding deadline of December 31st?

Any “employee” contributions to workplace retirement plans, such as 401ks and 403bs. Additionally, payroll deductions made to HSAs only count for the current year when made by 12/31 (though direct contributions can be made up until the tax filing deadline with FICA taxes owed on these amounts).

Q4: How do I avoid an IRS underpayment penalty?

You can avoid an underpayment penalty by meeting the IRS “safe harbor rule”, which can be done by paying at least 90% of your total current year tax liability, or at least 100% of the tax owed for the previous year. This jumps to 110% of the prior year’s tax bill if your AGI was over $150k (over $75k if married filing separately).

Q5: Is tax-loss harvesting worth it if I don’t have gains to offset?

Yes. If you don’t have capital gains, you can use up to $3,000 of investment losses each year to reduce ordinary income, with “unused” losses carried forward for use in future years.

Q6: When does a Roth conversion make sense?

Roth conversions often make the most sense in lower-income years or during market downturns, when the tax cost of converting those pre-tax dollars is relatively lower than it may be in other years (as long as you have the cash to pay the taxes).

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Fiduciary, fee-only, Certified Financial Planner, Eddy Jurgielewicz

Eddy Jurgielewicz, CFP® is a Partner and Lead Financial Planner at Upbeat Wealth, a fee-only firm based in New Orleans and serving clients virtually across the country. He specializes in providing straightforward financial guidance to ambitious young families as they navigate life’s many milestones.

Do you have questions about what we shared in this post, or anything else in general? Feel free to schedule a free consultation or drop us a line!

Sign up for our newsletter (at the bottom of this page) to stay up to speed on our Upbeat Insight.

Disclaimer: All content in this article is provided for educational, general information, and illustration purposes only. None of the information is intended as investment, tax, accounting, or legal advice. Nor is it a recommendation for purchase or sale of any security, or investment advisory services. We encourage you to consult with a financial planner, accountant, and/or legal professional for advice on your specific situation. Read our full disclaimer here.

Estate Planning: What Everyone Should Know

Estate Planning: What Everyone Should Know

When I cover the topic in meetings with clients, I often begin by asking what comes to their mind when they hear “estate planning”. A few will rattle off the names of documents, but the majority respond with what many of us are led to believe when left to our own devices, something like: trust fund… wealthy people… death… my parents…

What do you immediately think of?

Estate Planning is for Everyone

The first thing I’d like to loudly declare is that estate planning is for EVERYONE. Not just the “wealthy”. Not just for those who are older. And it includes decisions that may need to be made while you are alive. 

Not entirely convinced you need to create an estate plan? Take a moment to reflect on this [understandably wordy] question… 

“If you are no longer able to communicate for yourself, do you have any specific wishes for the type of healthcare treatment you’d receive, how your assets would be managed and distributed, or how your loved ones would be cared for?”

If any part of you thinks “yeah” or “probably”, then you need to create your own estate plan.

What is it that an Estate Plan Does?

Broadly speaking, an estate plan will:

  • Appoint trusted individuals to take on specific roles and make decisions according to your wishes when it comes to your healthcare received upon incapacitation, finances, and any minor children.
  • Ensure that your belongings and assets are efficiently directed to your loved ones and any organizations according to your guidelines. 

Naturally, what it is exactly that makes up an estate plan looks different person-to-person and family-to-family. But again, having the plan – YOUR plan – is essential.

What Happens if I Don’t Make an Estate Plan?

Who will raise your child?

What happens to the house?

Who will take care of your dog?

Who will get your most prized possessions?

Who will get any money you have, after debts and taxes are paid?

Who will make important medical decisions if you become incapacitated?

Who will be in charge of making sure everything gets distributed to your loved ones?

These are just a handful of the many questions that have to be answered at some point. They can either be answered exactly the way you want them to be. Or, in the absence of your plan, the court system in your state will handle it their way.

Probate… What is it?

The “probate court” is the portion of the state legal system that manages a person’s affairs upon their passing or even incapacitation. This process is usually referred to simply as “probate”, which can take time and, in some cases, come with a substantial cost. While each state has its own set of rules governing the proceedings, it generally involves facilitating the payment of any debts owed and then the distribution of any remaining assets based on the wishes set out in a will (if there is one).

Importantly, if you don’t have a will, the court will distribute any property and assets according to the laws of that state (though many assets can circumvent this process by simply naming a beneficiary – see below). Similarly, the court will determine any guardianship needs. It goes without saying that your wishes for who makes key decisions, who gets what, and who cares for whom may differ from what the state would decide… thus the importance of proper planning!

I trust you’re starting to pick up what I’m putting down here...

You already have an estate plan, whether you like it or not, even if you never sat down to make one. Because, ultimately, the decisions will be made by someone. It’s just a matter of how much control you want to have over the “who”, “what”, and “when” of it all.

So how do you maximize that control?

The Easiest First Steps

#1 Beneficiaries

Beneficiary designations are a fundamental part of any estate plan and something most people have already taken care of to some degree!

Some nice things about beneficiary designations:

  • It doesn’t cost anything to make them
  • Very easy to name them and make updates
  • They have priority over what any other legal documents might say
  • You don’t have to worry about the probate court getting involved here – the money passes directly to the appropriate person or entity

Given the gravity of beneficiaries, we recommend reviewing them regularly. 

You’ll want to be certain that they’re listed properly on all…

  • Life insurance policies (both workplace and personal)
  • Retirement and other investment accounts
  • Bank accounts and CDs

A few tips:

  • Make sure to list both primary and secondary beneficiaries.
  • Be mindful that it may be referred to as a “Payable on Death (POD)” designation for bank accounts and/or CDs, and potentially a “Transfer on Death (TOD)” designation for some brokerage accounts.
  • Tread carefully if naming a minor as beneficiary on life insurance or other accounts. This can potentially lead to complications or unwanted outcomes.

#2 Life Insurance

If someone else counts on your ability to earn money, then life insurance is a must! Putting the right coverage in place is the most effective way to ensure your loved ones are taken care of in the event you and your income are no longer here to support them.

For more of our thoughts on how to approach life insurance, read Mike’s post on the subject here.

The Basic Documents – What Everyone Should Have

Regardless of age, family situation, assets, or income, we recommend at least putting the following in place.

Financial Power of Attorney

This is a document that names an individual who will step in and act on your behalf for any financial matters if a time comes when you are not able to do so.

Health Care Power of Attorney

This document grants authority to someone (Health Care Agent) to make medical decisions on your behalf if you become incapacitated or too ill to make them yourself.

Living Will

This lays out specifically what medical treatments or life support you would want (or not want) if you are unable to speak for yourself.

Last Will & Testament

This document (also known simply as a “will”) spells out your wishes for how any belongings and other assets should be distributed. In the will, you will also name some key roles:

  • Executor: This person will essentially carry out the wishes expressed in your will.
  • Guardian: This is who will care for any minor children.
  • Beneficiaries: Individuals or organizations who will receive assets, particularly for non-financial assets (as these will be named on those accounts/policies)

Some Notes…

  • It’s possible to have the Financial Agent named in your Financial PoA document be the same person as the Executor listed in the Will, if you feel that would simplify things.
  • Think very carefully about who you’d like to assume each role. It’s even a good idea to ask them beforehand if they would be willing to take it on.

Here’s What Else You May Need, Based on Your Situation

If you have everything listed above locked in, then you’re likely in really good shape! The next “tier”, if you will, involves establishing a trust – something that may make sense for some and not be all that necessary for others.

How to know if I might need a trust?

The most common reasons to consider a trust result from the desire to…

  • Maintain maximum control over how and when your assets are distributed.
  • Keep things out of the public, lengthy, and potentially expensive probate process.

Other, more complex situations that lend themselves to creating a trust may include: owning property in multiple states, planning for a child with special needs, asset protection, and certain charitable giving goals.

What exactly is a trust?

Put simply, it is a legal arrangement that holds and manages your assets for your benefit and the benefit of anyone else you want. There are 3 key roles with a trust:

  • Grantor: The person who puts property/assets into the trust. Also called a “settlor” or “trustor”.
  • Trustee: This person is responsible for managing the assets within the trust for the benefit of the named beneficiaries, according to the grantor’s instructions.
  • Beneficiary: The person, people, or entity who receives the money, property, or income from the trust.

If you establish a “revocable” trust (most common), you’ll more than likely be the Trustee while you’re alive. Then, a named Successor Trustee will take over managing the trust assets upon your incapacitation or death. The Successor Trustee could be the same person as the Financial Agent and Executor, if you wanted.

What is a revocable trust?

Literally, it means you can “revoke” the trust arrangement, and it can be changed during your lifetime (as opposed to an “irrevocable” trust). Revocable trusts are set up while you’re alive, meaning it’s a type of “living trust” (compared to a “testamentary” trust, which takes effect upon the death of the grantor).

What does a trust do that a will can’t?

Probably the most practical benefit of a trust is that it allows you to determine when you want beneficiaries to receive certain assets during their lifetime. For example, with younger children, we often see clients schedule distributions in stages such as: ⅓ at age 25, ⅓ at 30, and ⅓ at 35. Chiefly, you have a lot of control over the resources inside the trust even once you’re no longer around. And again, it allows for assets or property to pass without the probate court getting involved.

Don’t forget!

After the trust is created, it is necessary to actually “fund the trust”! A lot of people hear this and get confused (or worse, don’t do it). All it means is that anything you want to be included in the trust and available as a resource to distribute according to your instructions needs to be structured to allow for that. Specifically, this involves retitling assets so that the trust is the owner. 

Some Ways to Get it All Done

Once you’re ready to take action, there are generally a few different paths you could take to actually get the plan done…

  1. Check your employee benefits: Some employers offer legal services as part of their benefits package. If available, it’s a relatively inexpensive way to engage an estate planning service and get your documents in order.
    • May total a few hundred bucks for the year.
  2. Online DIY service: There are a growing number of DIY-type services online that you can use to draw up the documents. This method tends to be better for the more straightforward scenarios, as you may not be able to consult directly with an attorney.
    • Typically can get done for under $1,000.
  3. Local attorney: If you have any level of complexity or simply want a more in-depth experience, this is the way to go. It’s the most expensive of the 3 options by a healthy margin, but could very well be worth it. 
    • Can easily run into the thousands of dollars.

What to Do Once The Documents Are Drawn Up

Once the documents have been reviewed, signed, and notarized… the work is not quite done!

  • Save and store them securely (both physical and digital copies)
  • Review the plan with your financial advisor
  • Talk to anyone with a role in your plan
  • Fund the trust (if one is created)
  • Share access to anyone who may need it

The Estate “Green Box”

This isn’t a “formal” part of an estate plan – and not an idea we came up with – but it can be incredibly valuable. 

You may know from experience, or can at least imagine, how deeply emotional the passing of a loved one can be. Think of the Green Box as the ultimate instruction manual for those you care about, as they attempt to pick up the pieces during what will be a very challenging time.

Include any of the following that pertain to your situation:

  • Letters to loved ones
  • A list of smaller mementos that aren’t listed in the Will and their intended recipients
  • Copy of your Will
  • Power of Attorney documents
  • List of passwords or the master password to your password manager
  • List of insurance policies
  • Net worth statement and the location of all financial accounts
  • Personal property appraisals (jewelry, collectibles, etc.)
  • List of trusted advisors (attorney, CPA, financial planner, etc.)
  • Business info (partner contracts, org sheets, succession plan documents)
  • … plus anything else you deem important or helpful!

It can be either physical or digital (it doesn’t need to be in a box). Once you’ve put all of this together, be sure to store it in a secure place, notifying the right people of its existence and location.

Admittedly, this is no small feat. And it will almost certainly be emotionally taxing. So give yourself plenty of time to take on the task. If you like to use the Spring to declutter your finances, maybe target getting this done toward the end of the year.

When to Revisit and Review It

At Upbeat Wealth, we revisit estate planning with our families every other year and find that to be a comfortable baseline cadence. However, there are life events that necessitate reviewing and updating your plan, such as getting married, divorce, having kids, moving to another state, buying/selling real estate, and so on…

Your estate plan will grow and evolve as your life does!

Conclusion

To sum it all up, here’s our recommended estate planning order of operations:

  1. Review Beneficiaries, as they override anything in your Will and are not subject to probate.
  2. Get or Review Life Insurance if someone depends on your earning potential.
  3. Create a Basic Estate Plan, or at least determine who will assume key roles if you are no longer able to do so. 
  4. Establish a Trust if you want to have more control over how your assets are distributed after death and/or to avoid probate.
  5. Create a “Green Box” that contains helpful information for those trying to pick up the pieces and do the heavy lifting after your passing during an incredibly emotional time.

The absolute best thing you can do to get started is simply talk about it. Get the wheels turning. While not the easiest topic to discuss, it’s far and away one of the most important. Reflect on what your wishes are, what they would be, and share them with loved ones. Write it all down. Then, get to work on formalizing the plan!

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Fiduciary, fee-only, Certified Financial Planner, Eddy Jurgielewicz

Eddy Jurgielewicz, CFP® is a Partner and Lead Financial Planner at Upbeat Wealth, a fee-only firm based in New Orleans and serving clients virtually across the country. He specializes in providing straightforward financial guidance to ambitious young families as they navigate life’s many milestones.

Do you have questions about what we shared in this post, or anything else in general? Feel free to schedule a free consultation or drop us a line!

Sign up for our newsletter (at the bottom of this page) to stay up to speed on our Upbeat Insight.

Disclaimer: All content in this article is provided for educational, general information, and illustration purposes only. None of the information is intended as investment, tax, accounting, or legal advice. Nor is it a recommendation for purchase or sale of any security, or investment advisory services. We encourage you to consult with a financial planner, accountant, and/or legal professional for advice on your specific situation. Read our full disclaimer here.

What to do With an Old 401k

What to do with an old 401k

Millennials have a knack for switching jobs throughout their careers. In our generation’s constant pursuit of workplace fulfillment, many suddenly find themselves one day with a collection of old employer retirement accounts. It’s kind of like unwittingly opening that random kitchen drawer only to discover a bursting assortment of koozies, collected from a couple of particularly busy wedding seasons and that one college alumni event that was somehow confident everyone in attendance would want 12 koozies each. 

Naturally, a frequent question we get working with couples in their 30s and 40s is: “What should I do with my old 401k(s)?” 

Whether you’re sitting on a stockpile and are uncertain of how to move forward (possibly the upcoming open enrollment season has reminded you of benefits past), or you’re preparing to make your first job switch and want to be prepared, this one’s for you!

You have FOUR Options

After separating from an employer, you can do one of four things with your old 401k:

  • Leave the account where it is
  • Roll it into a new employer plan
  • Move it into an IRA
  • Cash it out

Let’s break down each one and when they do (or don’t) make sense…

Option #1: Leave the old 401k where it is – with your former employer

This can be a good idea if…

  • Your next job doesn’t offer a retirement plan, you are implementing (or planning to implement) a backdoor Roth IRA strategy, and the 401k in question contains pre-tax money.
    • If your income is high enough to the point that the IRS says you cannot contribute directly to a Roth IRA, then you have to take the “backdoor” approach in order to put future dollars into a Roth IRA.
    • This means you ALSO need to pay attention to what’s called the “pro rata rule”. In short, if you have any pre-tax dollars in an IRA and then go about doing a Roth conversion, you’ll end up owing some taxes (even if you only convert an amount equal to after-tax contributions). The solution? Keep pre-tax money in employer retirement plans since the pro rata rule excludes those accounts. 
  • The old plan has a great list of investment fund options and low expenses.
    • Each company’s retirement plan has its own unique list of investment options available within the 401k. If the new plan is light on quality fund options and heavy on the fees, it may behoove you to keep that money put.
  • You don’t have the next job lined up yet.
    • There’s no need to rush into doing something with the old 401k. Wait until you have the next job secured to at least see how the new plan compares, so you can make the most informed decision.
  • You want to take advantage of the Rule of 55.
    • The Rule of 55 is a way for you to access retirement funds before age 59 ½ without owing that pesky 10% early withdrawal penalty to the IRS.
    • To do this, you must be 55 or older and have separated from your company. This type of distribution can only be taken from your most recent employer’s 401k (or 403b), not an IRA.
    • It’s important to note that not all 401k plans allow for this. While the IRS gives it the “ok”, the actual plan documents need to give it the green light as well.
    • This method for early retirement money access comes with somewhat more flexibility than the Substantially Equal Periodic Payment (SEPP) route, which can be used with both 401ks and IRAs.

Be mindful that...

  • You’ll be limited in how you can manage the account.
    • You can no longer add new money to the old 401k. However, you WILL still have full control over how the money is invested (within the list of investment options the plan offers).
  • More time and distance between you and a past employer can make it more difficult to access the account when needed.
    • Just how solid is your system for keeping track of usernames and passwords?
    • Your old company might decide to switch 401k providers, making the account more challenging to locate when you go back to hunt for it (“My account used to be held at Empower, but now it’s at Fidelity?? I’ve never even logged into Fidelity…”).
    • If an especially long period of time passes, there’s even a chance the money could be transferred to the state as unclaimed property.
  • If you have a smaller balance in the 401k, the plan administrator could take action on your behalf, without you requesting them to do so.
    • For old 401k balances under $7,000, there’s a chance that the plan automatically does any one of the following:
      • Cash out the balance and mail you a check, creating a taxable distribution (for balances under $1,000).
      • Move the money into an IRA (also for balances under $1,000).
      • Roll the funds into your new employer’s plan (sometimes for balances between $1,000 – $7,000).

Option #2: Roll the old 401k into your new employer’s plan

This can be a good idea if...

  • The new plan has a more robust investment fund lineup and/or lower fees.
    • It may not necessarily make-or-break your ability to one day retire, but better-performing funds and lower internal expenses add up over growing balances and several years. So it could certainly help get you to your target more efficiently.
  • The 401k has pre-tax dollars and you’re up against the pro rata rule.
    • Just like we discussed in the section above, it’s essential to keep pre-tax money in employer retirement plans when you’re utilizing the backdoor Roth IRA strategy. That means either leaving your old 401k where it is, or rolling it over into your new employer’s plan – as long as the money doesn’t go into an IRA.
  • You want to keep things as streamlined as possible.
    • There’s a real benefit to simplicity. Even in the case where the new 401k plan isn’t a clear “winner” over the old one in terms of investment selection and/or expenses – if they’re pretty close – consolidating the accounts will probably make your life easier down the line. 

Be mindful that...

  • We’ll capture some of the things to be aware of here, and with the other options, in the “General questions and considerations” section at the bottom.

Option #3: Roll the old 401k into an IRA

This can be a good idea if…

  • Your income is under the threshold that would prevent you from contributing directly to a Roth IRA.
    • In the case that you have pre-tax dollars in a Traditional 401k, BUT your income is under the IRS limit for making direct Roth IRA contributions, then you’ll be in the clear of that annoying pro rata rule (assuming that a Roth IRA will also be part of your plan) since you’ll be able to simply make future contributions right into the Roth. 
  • Your entire 401k balance is made up of Roth money.
    • If you don’t have any pre-tax funds in the 401k at all, then you don’t have to be cautious of this money sparking the pro rata rule when it gets moved into a Roth IRA. Again, it’s only pre-tax dollars in a Traditional IRA that make things tricky when doing the backdoor Roth IRA strategy down the line. 
    • Though increasingly rare these days, not all 401ks offer a Roth option. If that’s your new plan, then you’d have to go into a Roth IRA if you’re moving the money.
  • You want more investment options and/or lower fees.
    • By transferring the funds into an IRA, you’d then gain access to the full universe of investment options (mutual funds, ETFs, stocks, bonds, etc.). You can invest the money however you like, without being confined to a 401k plan’s set list of funds. This provides for greater control over the internal expenses that come with investments such as mutual funds and ETFs.
    • With an IRA, you can also pick whatever custodian you prefer, and there are plenty that have no management fees. 
  • You are seeking professional investment management.
    • Speaking of fees, professional management may or may not come with additional expenses, and it’s crucial to understand what those would be.
    • However, if you’re the kind of person who values someone with the appropriate level of expertise taking on some of the responsibility with your retirement savings, you might consider an IRA to allow for this level of guidance.
  • You want to do a Roth conversion.
    • If you have pre-tax money in the 401k and you’re in a position where it makes sense to execute a Roth conversion, then this could be an easy time to make it happen. Of course, you’ll need to be prepared for any taxes owed on the conversion. Note that some plans do allow for in-plan Roth conversions, so this could be a possibility with a new 401k as well.
  • You need some additional flexibility for penalty-free access of retirement funds for hardship or other life events.
    • The IRS grants some leniency to early withdrawals from IRAs (over 401ks) under certain circumstances. You get an exception to the 10% early withdrawal penalty in the following scenarios:
      • Up to $10,000 for a first-time home purchase
      • Covering qualified higher education expenses
      • Paying for health insurance while unemployed
    • Still, income tax is owed on anything you take out and you should ideally treat retirement accounts as an absolute last resort for accessing funds earlier in life. Just because this is an option does not mean it is always a good idea.

Be mindful that...

  • Roth money goes into a Roth, IRA and Traditional money goes into a Traditional IRA.
    • If you have both “types” of dollars in your one 401k plan, you’ll have to split the money between two IRAs when it gets rolled over, based on the tax treatment. 
  • A “Rollover IRA” is essentially the same as a “Traditional IRA”.
    • If you roll money from a 401k into an IRA, you will probably see the option to open a “Rollover IRA”. This account has the same tax treatment and contribution limits as a Traditional IRA. The IRS views these accounts through the same lens. You could choose to roll money from an employer plan into either one and you could then make contributions from earned income to either account. For all intents and purposes, the only real distinction is that you might opt for the “Rollover IRA” if you wanted to have some level of compartmentalization between retirement savings accumulated through past employers vs. those built up through your own contributions directly into a Traditional IRA.
    • It’s worth emphasizing here, too, that money in a Rollover IRA is factored into the pro rata rule the same as money in a Traditional IRA!
  • You need to actually invest the money.
    • When the money is sent to your IRA from the 401k, it will come over as cash. It’s then on you to make sure it gets invested. This is a critical step. 
  • In many cases, you should be able to move money from an IRA into a current employer 401k plan if needed in the future.
    • You’ll need to check with your current employer’s 401k plan documents to see if they allow for this “reverse rollover” (not all do).
    • You can only transfer money from an IRA into the 401k of a company where you’re presently working.
    • And why might you consider doing this? The most typical reason I come across is when your income has grown to the point of necessitating the backdoor Roth IRA strategy and we want to be sure you’re staying clear of issues with the pro rata rule. 
  • While the Rule of 55 exists for 401ks, Rule 72(t) (Substantially Equal Periodic Payments) is a way to access funds without the early withdrawal penalty from IRAs (and 401ks too).
    • There’s a little less flexibility with how funds are accessed under this rule, specifically in regards to the amount and timeline of withdrawals.

Option #4: Cash out the 401k

Yes, technically an option… But not one you really want to give any thought to.

In short, don’t do it! By choosing to cash out your old 401k, you’re creating a fully taxable event (if it’s pre-tax money) and potentially exposing yourself to the 10% early withdrawal penalty if you’re below age 59 ½. Not to mention, you’re likely better off keeping those retirement savings invested and working toward your long-term financial security.

General considerations

  • If you have an outstanding 401k loan….
    • Upon separating from your employer, you’ll have a short period of time to pay back the full balance of the loan.
    • If you don’t pay off the loan in the plan’s prescribed timeframe, the remaining amount owed is treated as a taxable distribution (which could also come with a 10% early withdrawal penalty if you’re younger than 59 ½). 
  • Choosing between a direct rollover vs. an indirect rollover…
    • A “direct rollover” is one in which the 401k money is sent straight to the new IRA or 401k institution and never touches your hands. This is the easier and preferred method.
    • With an “indirect rollover”, a check is sent to you. You then have up to 60 days to deposit the money with the new institution before taxes and penalties kick in. We recommend avoiding this type of rollover given the potential for taxes/penalty in the event it’s not handled in time, plus the increased chance of the check not making it to its appropriate destination.
  • Take note of your vested balance…
    • Your “vested” balance is how much of the account you can access or move, whereas the “unvested” balance is forfeited upon separating from your employer. The unvested portion won’t ever be accessible to you, regardless of what you do with the 401k.
  • Understand the tax status of your 401k dollars (Pre-tax vs. Roth)…
    • It’s important that the tax status of any new account you move 401k funds into matches the tax status the dollars had while in your 401k (Traditional → Traditional and Roth → Roth). You risk creating a taxable event if this gets mixed up.
  • Be wary of the “advisor” who tells you that you have to move your old 401k into an IRA…
    • As we’ve laid out here, your only option isn’t to move money from your 401k into an IRA. In fact, it very well may be in your best interest to leave it where it is or roll it into your new employer’s 401k. 
  • If you think you might have an old 401k sitting around somewhere, but aren’t sure…
    • There are resources out there that can help you track down lost employer retirement plans. One such example is the Department of Labor’s Retirement Savings Lost and Found.

As for the koozies, your four options are:

  1. Make a quilt
  2. Develop a daily koozie rotation to justify the obscene number
  3. Decide which friends/organizations you love the most and toss the rest
  4. Dump the whole drawer and move on
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Fiduciary, fee-only, Certified Financial Planner, Eddy Jurgielewicz

Eddy Jurgielewicz, CFP® is a Partner and Lead Financial Planner at Upbeat Wealth, a fee-only firm based in New Orleans and serving clients virtually across the country. He specializes in providing straightforward financial guidance to ambitious young families as they navigate life’s many milestones.

Do you have questions about what we shared in this post, or anything else in general? Feel free to schedule a free consultation or drop us a line!

Sign up for our newsletter (at the bottom of this page) to stay up to speed on our Upbeat Insight.

Disclaimer: All content in this article is provided for educational, general information, and illustration purposes only. None of the information is intended as investment, tax, accounting, or legal advice. Nor is it a recommendation for purchase or sale of any security, or investment advisory services. We encourage you to consult with a financial planner, accountant, and/or legal professional for advice on your specific situation. Read our full disclaimer here.

Incentive Stock Options – Part 3: Decision-Making

ISOs Decision-Making

By now, you’ve hopefully developed a baseline understanding of just what exactly incentive stock options even are and have a working sense of how taxes fit into the equation. Equipped with that knowledge, the final step in readying yourself to make the most of your equity is to put all the pieces together. In this post, we put rubber to the road and dissect many of the decisions you’ll likely face with ISOs!

When it comes to ISOs, here are the high-level decisions you’ll face…

  1. Evaluate if you even want to exercise at all
  2. Determine how much you’ll exercise
  3. Calculate the cost to exercise
  4. Plan for how you’ll cover the cost
  5. Develop a strategy for when to exercise
  6. Decide when the shares will be sold

And, of course, manage the tax consequences throughout. It amounts to quite a bit, so the best thing you can do to position yourself for success is to get ahead of it!

TO EXERCISE OR NOT TO EXERCISE?

Options are just that – options. You’re not required to do anything with them at all (though you often should!).

Evaluating whether or not to exercise is an investment decision above all else. So you have to first assess your personal comfort level with investment risk and understand how such risk will influence the rest of your financial picture. While ISOs have the potential to create real wealth, it’s also possible to lose money. Therefore, some initial questions you’ll need to answer first include:

How much do I believe in this company?

  • If you’re super confident in its future success, then maybe it’s worth investing your money.
  • If you’re doubtful, set some limits on what you put in, if anything at all.

How diversified is the rest of my investment portfolio?

  • When you exercise, you now own stock in your company. Owning too much of any single stock creates added risk – think, “don’t put all your eggs in one basket”. 
  • Would exercising mean that a majority of your net worth is now tied directly to the performance of your employer? If this is the case, tread carefully.
  • Once a holding of an individual stock starts to exceed 5% of your total liquid net worth, we want to be especially careful and really consider the impact on your goals given that stock’s potential performance.
  • On the other hand, if after exercising you’d still have a healthy amount of your net worth allocated to other investment accounts that are well-diversified to suit your goals and risk tolerance, then it becomes a less risky decision to own the shares in your company.

Is my company private or public?

  • This gets into how easily you’d be able to sell the shares after exercising.
  • If your company is still private, know that it may be difficult (or impossible) to sell the shares until there’s some type of liquidity event, such as an IPO or acquisition. This can add a level of risk to the decision.
  • If your employer is already public, or about to be, then selling will be far easier (though you may still need to be mindful of “blackout windows” during which you cannot sell). This can make exercising a little more manageable if you want to be able to quickly pivot away from holding the stock.

Can I afford the cost to exercise?

  • We’ll dive more into how you can pay for the exercise below, but there’s certainly a real cost involved. 
  • Ultimately, it’s important to balance this with everything else you have going on.

As we continue from here, we’re going to examine very specific scenarios at each of the following stages…

HOW MUCH TO EXERCISE

Exercise up to the AMT limit as a ceiling

If you’re looking to optimize ISOs in such a way that the only taxes owed are long-term capital gains (no AMT or ordinary income tax), then this is the way to go. 

The way it works… You’ll want to determine the available spread you could realize before tipping the scales into AMT territory. This will tell you how many options can be exercised without pushing you out of the standard tax system and then owing AMT. Staying within this limit means no taxes are owed in the year of exercise. For those who have a big pile of ISOs built up, it often means implementing this strategy over multiple years to exercise them all without ever triggering AMT.

Note: You would NOT want to do this if you have a large AMT credit, since it would diminish or prevent your ability to recoup that credit.

* A SPECIAL SECTION ON THE AMT CREDIT *

Hearing that you might owe more, or a different kind of tax can be anxiety-inducing. And it’s a valid response. The “standard” income tax system is unnecessarily complicated on its own. To learn there’s an additional tax system that often comes into the picture for those with ISOs is enough to make some people dizzy.

What is the AMT credit?

In reality, paying AMT isn’t always worth avoiding like the plague. That’s because you get a tax credit when AMT is paid. This credit is equal to the difference between the tax liability of the two systems. For example, if your AMT liability was $200,000 and your standard tax liability was $150,000… 

  • First of all, you’d pay AMT that year because it’s higher. 
  • Second, you’d get a credit of $50,000 ($200k – $150k).

Using the credit

This credit can then be used in future years, but only in years that your standard tax bill is higher (meaning you pay taxes under the regular system, not AMT). Additionally, the amount of credit you can use in those years is limited to the difference between the two tax liabilities. So let’s say you have the same $50,000 credit from above for a prior year and your current year’s tax situation looks as follows:

  • Standard tax liability: $175,000
  • AMT liability: $150,000

You’d pay the standard tax because it’s the higher amount, and you’d only be able to use $25,000 of the $50,000 credit for this year ($175k – $150k). The remaining $25,000 of unused credit carries forward to future years.

All this to say...

If you unexpectedly exercise ISOs to a point that forces you to pay AMT in a given year, all is not lost! Depending on the amount, it may be possible to “get it back”. Still, be mindful that if there’s a large enough bargain element, it could be quite a hurdle to cover the subsequent AMT bill that’s been created come April in the year following exercise – at least if you want to avoid selling the shares. Further, the process for recouping an AMT credit adds even more complexity that some may prefer to do without. There’s additional nuance involved that’s outside the scope of this post.

CALCULATING THE COST

This is straightforward! Simply multiply the exercise price (AKA strike price) by the number of options you plan to exercise.

Example...

  • # of Vested Options: 500
  • Strike Price: $4.50
  • Cost to Exercise 500 Options: 500 x $4.5 = $2,250

* this does not include potential AMT, which should be factored into the cost if applicable *

HOW YOU’LL COVER THE COST

All stock option plans allow you to exercise by paying for the options with your own cash. Some plans will also allow for what’s called a “cashless” exercise, meaning you don’t have to come up with the funds yourself.

So, if you have the choice to make, the question becomes… Exercise with cash or go cashless?

How a cash exercise works…

  • Simply come up with the cash (for example: take money from savings)
  • Once you exercise, it’s entirely up to you as far as what you do with the shares next
    • When you sell…
    • How many you sell…
    • How you cover the tax liability…

How a cashless exercise works…

  • First, you need to check the details of your company’s stock plan to confirm that this exercise method is allowed by your employer.
  • If it is, then you’ll need to select one of two routes for your cashless exercise:
  • Exercise and sell to cover
    • In this transaction, the desired number of options is exercised and, at the same time, enough shares are immediately sold so that just enough money is raised to cover the exercise cost (along with any fees and taxes).
    • You keep the leftover shares to then sell when you want down the road.
    • Put simply: exercise without bringing money to the table and walk away with shares in the company.
  • Exercise and sell all
    • Choosing this method means that your desired options are exercised and then ALL of the shares are simultaneously sold.
    • In doing so, a portion of the proceeds is used to cover the cost of the exercise, plus any fees and taxes. The rest is paid out to you.
    • Put simply: exercise without bringing money to the table and walk away with just cash.

So which one should you go with?

Consider a cash exercise if…

  • You have plenty of liquidity (easy access to cash) over and above your emergency fund + any short-term needs, and are ok with the increased concentration of your wealth into the company stock.
  • You want to maximize the number of shares you’re able to hold onto.
  • You want the most control of the tax consequences and are targeting a qualified disposition for as many shares as possible.

Consider a cashless exercise if…

  • You aren’t in a position to pull from savings or other resources to foot the bill.
  • You are ok with some (or all) of the shares being sold right away as a disqualified disposition.
  • You are ready to quickly capitalize on the value of the stock options

WHEN TO EXERCISE

There are a lot of alternatives when it comes to the timing of your exercise:

  • Earlier in the overall vesting schedule
  • Waiting until later on in the vesting schedule, or beyond
  • An “early exercise” before they even vest
  • Early within a calendar year
  • Later in the calendar year

Why consider exercising sooner in the grand scheme of your award vest? (not referring to an 83b election – just earlier rather than later)

  • Get a jump on the holding period requirement for the shares to be classified as “qualified” when eventually sold, earning long-term capital gains tax treatment on the full difference between the exercise price and FMV at sale.
  • Allow yourself to exercise more options, given the AMT threshold…
    • Earlier on in the lifecycle of your award grant and vest timeline, it’s more likely that the current FMV/409A of your company is lower, thus closer to whatever the exercise price of the options is (or in some cases, the same).
    • If the spread is smaller, you’ll be able to exercise more options without pushing into AMT territory compared to if the FMV/409A of the company balloons significantly.
    • In short: lower spread = lower AMT income realized
  • You’re confident in the future performance of the company and expect the share price to increase. Plus you’re ok with the risk that the price could also go down if the company takes a turn, leading to a loss on your investment.
  • You anticipate some type of liquidity event (IPO/acquisition) that would allow you to cash in on the shares in the future.

Why consider exercising later?

  • You’re not confident in the future trajectory of the companyand you’d prefer to see how the share price moves before putting up the money to exercise the options.
  • The options are currently “out of the money”… This means that the strike price is higher than the current FMV/409A. In other words, there’s no value to be gained. You’d pay more to exercise the options that you could get for selling the shares.
  • You don’t have the cash on hand to easily cover the cost and/or there’s no ability for a cashless exercise.

Ok, what if you are able to “early exercise” with an 83b election?

Some companies will give you the ability to exercise your options early – even before they vest. If this is the case, it could deliver a big tax win. 

The way it works… Instead of waiting a year+ to start exercising in many cases (based on the vesting schedule), you could choose to do so as early as being granted the options. Remember, the spread between the strike price and FMV at the time of exercise is what counts as income for calculating AMT. If this spread is very small, or even nonexistent due to the 409A being the same as the strike price early on – then it could translate to a large number of options exercised with little or no income under AMT.

This method would require coming up with the cash, as a cashless exercise isn’t a possibility at this point. So it might be a cost that’s not realistic or worthy to take on, depending on the strike price. It’s also an even earlier bet that your company will be successful and make the options worth something for you in the future, so there’s added risk involved.

Lastly, if you pursue this, you must file what’s called an “83b election” with the IRS within 30 days of the exercise.

Now, what about the timing of the exercise within the year – exercising early in the year vs. later in the year?

Exercise Later in the Year – Using the AMT Threshold as a Ceiling

If you are using the AMT threshold as a limit for how much you plan to exercise, as discussed earlier in this post, then it makes sense to wait until later in the calendar year. That’s because this approach requires a heavy level of tax projections. So it’s helpful to have the bulk of the data making up your full tax picture, which becomes clearer at the end of the year.

Exercise Early in the Year – To Maximize Choice

This technique only provides value if your employer is a publicly traded company.

Exercising early in the calendar year (no later than April) delivers some handy flexibility as you manage next steps by allowing you to:

  • Decide between holding onto the shares long enough to meet the criteria for a qualifying disposition (more than 1 year), or sell during that same calendar year to avoid AMT.
  • [Should you choose the first of the above two options] Have more time to plan for how you’ll cover the AMT owed, if any.

For example, if you exercise on February 1st of 2025, taxes are due in April of 2026 – a little over 14 months later. In this scenario…

  • You could easily meet the holding requirement for long-term capital gains treatment that comes with a qualifying disposition (by selling after February 1st, 2026). Selling the shares would also raise cash that could be used to pay any AMT owed.
  • On the other hand, if the share price drops during the same tax year to a point where there is no longer a capital gain, it very well may make sense to sell the shares as a disqualifying disposition. In this case, there would be no AMT owed, and there wouldn’t have been a benefit to holding for 1+ year if there was no capital gain to be realized.

What if you separate from your employer?

If your employment is terminated, an important clock begins ticking immediately: your vested ISOs will convert to nonqualified stock options within 90 days. NSOs are less beneficial from a tax standpoint since the spread at exercise is always taxed at ordinary income rates.

So if your goal is to exercise after separation and you want the tax benefits of incentive stock options, it will require you to act quickly. If, on the other hand, you’re good with the tax treatment of NSOs or simply don’t want to rush into an exercise, you may still have time – often up to 10 years. To be certain, it’s best to check with your employer to confirm the details of their “post termination exercise period” (PTEP) so you know how long you have before the options expire completely.

WHEN TO SELL

Hold onto the exercised stock long enough to meet the requirements for a qualifying disposition…

Holding the shares for at least 2 years from the grant date and at least 1 year from exercise allows you to take advantage of the kinder long-term capital gains tax rate when they’re sold (compared to your higher ordinary income tax rate).

* Keep in mind that this route requires you to factor in the potential AMT impact * 

This is worth considering if:

  • You are able to take on the added investment risk of a large position in your company’s stock.
  • The cash that could otherwise be generated from selling isn’t needed for any short-term goals.
  • You believe the stock price will increase with time (and are comfortable with the possibility of a decline in value).

You shouldn’t go for this if:

  • You are uncomfortable with increased investment risk. Accumulating a big position of any single stock carries heightened risk, and often more so if that stock is in a younger company.
  • The cash you could receive by selling will be instrumental in working toward an important goal (such as paying down high interest debt, funding a major purchase, etc.).
  • You doubt the future performance of the company.

Selling sooner, as a disqualifying disposition…

Sometimes, your decision is – at least partly – already made if you’ve executed a cashless exercise. Remember, if you sell to cover → a portion of the shares is immediately sold to cover taxes. Or, as part of a cashless exercise, you may elect to immediately sell all the shares in the same transaction.

Selling all the shares immediately might be necessary to help cover the cost of exercising and the taxes, but it can also be strategic if the proceeds will be put towards another meaningful financial goal. Additionally, this is a way to simply reduce the risk that comes with building up a large portion of your net worth in your employer, by then investing the proceeds in a diversified portfolio.

Finally, unloading the shares as a disqualifying disposition becomes the smart move if it’s done to avoid paying AMT on shares that no longer look like they’d yield any capital gains – like I shared above.

Here’s an important point with all this…

  • To some extent (*disclaimer to always check with your tax professional first*), it’s not necessarily worth getting all caught up in the mental tug-of-war over selling shares as a “qualified” or “disqualified” disposition.
  • Remember that there’s inherent risk involved in holding onto the shares for over a year with the hopes of paying less in taxes by way of long-term capital gains treatment. For young companies, much can happen in those 365+ days after exercising. If the price takes a hit, it very well could erase any potential tax benefit you would have otherwise received.
  • Money is money. 
    • If you’re prepared for the taxes involved, a disqualifying disposition can still be (and often is) an incredibly positive life-changing event.
      • It could be what allows you to… buy that dream home, take the trip you’ve been putting off for years, spend more time with family, and so on.
    • Don’t discount the value it delivers to your life just because it isn’t the most “optimal” tax scenario.

MAKE IT HAPPEN

Given all the nuance involved, we always recommend working closely with a financial and tax professional to carefully evaluate the most appropriate path forward with incentive stock options. In doing so, they’ll be able to help you:

  1. Know the purpose of your plan… How will this resource best support you in achieving your ideal life?
  2. Lay out all of the options (not the ISOs, but the scenarios) side-by-side.
  3. Understand all the possible implications… The tax impacts, investment risks/benefits, what you’re saying “yes” to and what that means you’d be saying “no” to, etc…
  4. Create an action plan and put it into motion.

Building this plan in advance helps to minimize the emotion attached to the process and increases your chances of successfully following through.

Incentive Stock Options – Part 2: Tax Planning

ISOs - Tax Planning

Once you have a firm grasp on the fundamentals of incentive stock options, it’s time to peel back the layers on their tax implications. While they can seem needlessly complex, rest assured that ISOs do have plenty of positive attributes when it comes to their relationship with taxes. So it pays to get a handle on it.

To tackle this, we’ll examine some very specific tax-related questions:

  • What unique tax advantages do ISOs have?
  • What is the Alternative Minimum Tax?
  • Why do I need to worry about AMT with ISOs?
  • What are the different tax scenarios I could face when selling exercised ISOs?
  • What types of taxes are owed?
  • What are the possible advantages of an early exercise (if available)?
  • How should you cover the tax liability associated with selling stock acquired through an ISO grant?
  • What ISO-specific tax documents and forms should you be on the lookout for?

And if you need a refresher on all the ISO terminology, be sure to visit the bottom of our Part 1 post for a list of must-know definitions!

What unique tax advantages do ISOs have?

The headline tax benefit of incentive stock options boils down to WHEN you pay taxes and the TYPE of taxes you’ll owe.

ISOs are not taxed at all when they’re granted or when they vest. The kicker is that – unless AMT is owed – there is also no tax liability created when you exercise either. What’s more, it’s possible in some scenarios that the entire financial benefit realized through an ISO exercise and subsequent sale is taxed at the friendlier capital gains tax rate (vs. ordinary income rate).

For comparison… In the case of their equity comp cousin – Restricted Stock Units (RSUs) – the value at the time of vest is immediately counted towards your ordinary income for that year. And for the more closely related sibling – non-qualified stock options (NSOs) – you should expect to pay ordinary income tax at exercise.

when do I pay taxes on ISOs

What is the Alternative Minimum Tax?

The Alternative Minimum Tax (AMT) is an entirely separate tax system and calculation that exists in addition to the “regular” one most of us are accustomed to. Technically, everyone should calculate both their regular tax and AMT liability each year – then pay whichever is higher. But for the vast majority of people, the “regular” tax amount is the bigger bill. 

One of the big differences between the two tax systems is that some of the credits and deductions people can take when calculating their regular tax don’t apply for AMT. A good example is the deduction for state and local taxes – it can’t be taken at all under AMT. This gets at why the system was created in the first place, as a way to try and make sure some wealthier individuals weren’t benefiting too much from credits and deductions in the regular tax framework.

The alternative minimum tax has different tax rates and standard deductions. On top of federal AMT, some states have their own version. Those lucky states are California, Colorado, Connecticut, Iowa, and Minnesota.

Why do I need to worry about AMT with ISOs?

The spread (difference between the strike price and FMV on the date of exercise) is not taxable under the normal tax system. It’s not considered income on Form 1040. Unfortunately, the spread is one of those pesky items considered income for AMT purposes and is thus factored in on Form 6251, which is used to calculate an individual’s Alternative Minimum Tax liability.

If you exercise ISOs and do NOT sell them in the same tax year, you need to check to see if this pushes you into AMT territory. If, however, you do sell the shares in the same year as exercise, the spread will not need to be added into the AMT calculation. 

Bear in mind that just because you have an ISO spread for the year, it doesn’t mean you’ll owe AMT. It’s only if it pushes your AMT liability to a higher amount than your regular tax liability comes out to be.

What are the different tax scenarios I could face when selling exercised ISOs?

Moving on from exercising incentive stock options to selling the shares here… Again, this might be the first time many recipients of ISOs have to worry about paying any taxes.

It’s important to know that there is no default withholding when you sell the shares you received from an exercise. Therefore, it’s on you (plus your advisor and CPA, hopefully!) to proactively assess taxes that are due and how/when to pay them. The first step is to determine whether the sale of the ISO shares is considered a qualifying disposition or a disqualifying disposition.

Qualifying Disposition

The sale is a qualifying disposition if the stock was held for at least 1 year after exercise AND at least 2 years after the grant date. In this case, ALL proceeds are taxed at the more generous long-term capital gains rate. Your basis in the sale is whatever the strike price was. So your spread PLUS any increase in value after exercise get that preferential tax treatment.

Of course, the stock price could decline after exercise. If this were to occur, then you would still pay long-term capital gains tax on the difference between the FMV on the date of sale and the strike price.

Disqualifying Disposition

The sale is classified as a disqualifying disposition if it does not meet both of the criteria mentioned above. In this event, the tax situation could play out a couple of different ways…

No matter what, the spread is taxed at ordinary income tax rates in a disqualifying disposition. If the holding period of the stock is less than one year after exercise, any gain is also taxed at your ordinary income tax rate (short-term capital gain). In less common situations, the holding period could be more than 1 year from exercise, but less than 2 years from grant – in which case the spread is still taxed at ordinary income tax rates, but any gains would get long-term capital gains treatment.

Will I owe Social Security and Medicare taxes when selling ISOs?

Social Security and Medicare (FICA) taxes are NOT owed on ISOs when they’re sold, regardless of whether it’s a qualifying or disqualifying disposition. So you only have to worry about federal and state taxes (if you live in a state with income tax).

As described above, you may encounter ordinary income tax AND/OR capital gains taxes at the point of sale.

What are the pros/cons of an early exercise (if available)?

If your employer allows for early exercise (not all do), it is worth evaluating whether it makes sense in your situation! The ability to exercise the options before they even vest comes with potential advantages, but you should be aware of the possible downsides too.

The main reasons to consider an early exercise

  • You may be buying the stock when the strike price is the same as the FMV or the difference is very slim. This means that the income included in your AMT calculation is $0 or close to it – potentially helping to reduce or avoid any tax impact at exercise.
  • Early exercise starts the clock on your holding period, speeding up the time it takes to achieve a qualifying disposition and for applying long-term capital gains tax to the full gain. 
  • For those at a company eligible to be classified as a qualified small business, it starts the clock on their QSBS holding period – which can lead to some rather dramatic exclusions on capital gains.
  • You’re especially confident that the company will perform well.

The main pitfalls of an early exercise

  • It’s a very early bet and the company might not make it. 
  • It will likely be hard to dispose of your shares for some time. The company is private and it’s hard to know when a liquidity event will come around.
  • It requires a fully cash purchase, so you need to have the savings available to part with (unless you finance it).
  • Early exercise does NOT change the vesting schedule of the ISOs. So you still have to stick around to collect them. If you were to end up leaving the company before all the shares vest, the company could buy back any unvested stock that you exercised early.

Remember from Part 1 that an early exercise requires filing an 83(b) election within 30 days of the exercise.

How should you cover the tax liability associated with selling stock acquired through an ISO grant?

If ISOs work out and make you money, you’re going to have to pay taxes. But remember that there’s no default tax withholding when you sell the shares, and failing to pay enough taxes during the year could result in a penalty from the IRS. They like getting what they’re due when it’s due. To know what “enough” is, you need to calculate what’s called your safe harbor threshold, which can be figured one of two ways:

  • 100% of last year’s total tax bill (or 110% for those with an AGI over $150k)
  • 90% of the eventual tax bill owed for the current year (more difficult to know)

If any tax liability generated from selling ISO shares pushes your total projected tax for the year over the safe harbor amount, you need a plan to pay the tax on that income as it’s received. We recommend either paying estimated quarterly taxes or increasing the withholding on your regular paycheck by updating your W-4 to cover the tax gap.

What ISO-specific tax documents and forms should you be on the lookout for?

Come tax time, your life will be much easier if you know what paperwork to gather. There are also a couple pages in the tax return that you’ll need to be sure to complete if you sold company stock.

What you’ll need to help you prepare your taxes

  • W-2
    • This one shouldn’t be anything new. Just know that if you had a disqualifying disposition of ISOs, the income generated from that transaction will be included in the amount in box 1.
    • This is sent to you by your employer.
  • Form 3921
    • This form contains information for any ISO exercise.
    • It’s provided by your employer (or possibly a broker, or 3rd party).
  • Form 1099-B
    • This includes details about any sale of stock and the associated capital gains/losses.
    • You’ll get this form from the custodian that holds the account the stock was in.

Forms to fill out on your tax return

  • Form 1040
    • This should look familiar. It’s the first page of the return and reports your income for the year.
  • Schedule D
    • This page reports the total gains and/or losses from the sale of stock during the year.
  • Form 8949
    • This is used to list out the specifics of each stock sale.

Wrapping It Up

Don’t let the tax intricacies of ISOs keep you from taking advantage of them in the most optimal way! There is potentially a lot to be gained, but it starts with taking the time to understand all the rules. Lastly, stay tuned for the final post in this 3-part ISO series, which will revolve around decision-making strategies and tie it all together.

Still have questions? Keep up with our latest insights by subscribing to our monthly newsletter. Or reach out!

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Fiduciary, fee-only, Certified Financial Planner, Eddy Jurgielewicz

Eddy Jurgielewicz, CFP® is a Partner and Lead Financial Planner at Upbeat Wealth, a fee-only firm based in New Orleans and serving clients virtually across the country. He specializes in providing straightforward financial guidance to ambitious young families as they navigate life’s many milestones.

Do you have questions about what we shared in this post, or anything else in general? Feel free to schedule a free consultation or drop us a line!

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Disclaimer: All content in this article is provided for educational, general information, and illustration purposes only. None of the information is intended as investment, tax, accounting, or legal advice. Nor is it a recommendation for purchase or sale of any security, or investment advisory services. We encourage you to consult with a financial planner, accountant, and/or legal professional for advice on your specific situation. Read our full disclaimer here.

Incentive Stock Options – Part 1: What Are They?

Incentive Stock Options - What Are They

Stock options are a major player when it comes to equity compensation, especially for those who work in the tech startup space. Not to be confused with their cousin, restricted stock units, they come in two flavors: nonqualified stock options (NQSOs) and incentive stock options (ISOs). We’ll focus on ISOs here!

Quick Tip!

The world of ISOs is filled with lots of fun terminology. To help make things easier, I’ve included a list of essential vocabulary at the bottom of this post.

I suggest glancing at that first! If you’ve only just been handed your first ISO award, the vocabulary alone will be well worth reviewing.

As far as milestones go, ISO grants and the cascade of decisions that need to be made after create quite a series of inflection points in your financial journey. Beyond helping you speak the language, we’ll take a comprehensive approach to understanding incentive stock options in the context of your life. 

In an attempt to do it justice, I’m going to break up the topic into a series of 3 separate posts with their own general theme:

  • In this post, we’ll explore exactly what ISOs are
  • In Part 2, we’ll get into the various tax implications to anticipate and prepare for
  • And in Part 3, we’ll cover a framework for decision-making – how to actually position ISOs as a tool to support your goals

So stay tuned for the follow-up pieces!

With that, let’s jump into the “what” of incentive stock options…

Overview

Put simply, an “incentive stock option” is an agreement between you and your employer that gives you the right to buy stock in your company at a pre-determined price, as long as certain conditions are met. They are commonly offered as part of an overall compensation package at early-stage, private startups (alternatively, RSUs are more typically offered at public companies). Note that options are merely that… an option. It is your choice to act on them, not a requirement. 

ISO ≠ a stock

ISO ≠ an obligation

The greatest incentive stock option success stories have produced millionaires overnight thanks to the unique ability of ISOs (in a best case scenario) to amplify and speed up the most fundamental rule of investing: buy very low → sell for a lot higher.

Of course, sound planning (and, to be fair, in plenty of cases, a healthy dose of old-fashioned luck) goes a long way in leading to such positive results.

The Life Stages of an Incentive Stock Option

To help further understand how this type of equity compensation can generate such wealth, let’s lay out the basic mechanics of ISOs.

Grant

ISOs are given to employees in the form of a “grant” or award. This usually happens at the point of hire and/or later on when compensation is adjusted, or as part of a promotion. These grants are for batches of ISOs. For example, a grant might be in the form of 100 ISOs – which means that you receive the option to purchase up to 100 shares of your company at a future point.

Vesting

Enter the first component of the “incentive”. Your employer has said, “Here’s this potentially awesome benefit, but… you’ll need to stick around for a while if you want to actually reap the reward.”

You won’t be able to do anything with your ISOs right away (*unless your employer allows for early exercise – more on this later*). Instead, you’ll have to wait patiently for the ISOs to vest over time. Only after they vest are you then able to do “the something” that creates any real value for you. You’re likely to see a schedule that starts with a “cliff”. During this time, no ISOs will vest at all. But once that cliff ends, they’ll begin to vest according to the established schedule. For example, if the schedule is quarterly for 4 years with a 1-year cliff – the first set of options will vest 12 months from the date of grant and then each quarter thereafter for the next 3 years.

Exercise

We’ve arrived at another aspect of the “incentive”. As soon as the ISOs vest, you have the opportunity to convert them into shares of company stock. Put another way, you can now choose to exercise your option to buy the stock.

The perk is this: You get to purchase the underlying stock for the stated “strike price”, which is specified at the time of grant. The idea – and hope – is that the strike price (for which you buy the stock) is LESS THAN the current fair market value (amount you could immediately sell the stock for). If that’s the case, then you are able to produce tangible cash value from the incentive stock options if you exercise and sell them right away. 

Alternatively, you may choose to exercise the ISOs and then hold onto the shares, hoping for even more growth in the stock price before eventually selling (plus a long enough holding period to create a “qualified disposition” – more below). Either way, exercising an option leads to ownership of the stock. Once you own the stock, it is then yours to sell when you like. 

In terms of ISOs, this is the first big decision you’ll have to make. Note that you do NOT have to exercise your options at the moment of vesting. You can decide to do so later on, or not at all. Additionally, it’s up to you how many ISOs you exercise – it’s not an all-or-nothing deal.

Be aware that, if you don’t exercise, the options have an expiration date. In most cases, they will expire after 10 years.

Sell

Upon taking ownership of the underlying stock, the next major question becomes… When do you sell? Of course, you don’t derive any true value from a stock until it is sold for more money than you bought it for.

Let’s take a look at an example that illustrates how this could play out…

Virginia works for a hot new tech startup called Sovereign AI.

Incentive Stock Option Example

After Virginia’s grant, Sovereign AI experienced a liquidity event and went public. As a result, the stock is currently trading on the open market at $25 per share.

Let’s say today is February 2nd, 2025, and Virginia has not done anything with her ISOs yet.

If she were to exercise all the shares that have vested so far (200), she would pay a total of $100 (200 x 0.50). She could then sell them immediately for $25/share. Doing so would result in proceeds of $4,900 ([200 x 25] – 100), before taxes.

* We have not accounted for any taxes in this example *

Admittedly, this is a pretty straightforward example. Nonetheless, it shows us the basic lifecycle of an ISO…

Grant  →  Vest  →  Exercise  →  Sell

Oftentimes, an employee will see their options vest before a liquidity event occurs. While the value of their private company stock at the time of vest may be higher than the strike price, it might not be by much. Still, it can be wise to exercise even at that point and hold onto the stock until a later date. Or maybe there’s a scenario where the current value of the company stock is less than the strike price – meaning the options are worthless. If that’s the case, the best thing could be to hold off on exercising until the value hopefully goes back up.

What to Expect if You Leave Your Employer

There are some important things to be aware of in the event your employment comes to an end, whether by choice or otherwise. It all comes down to the life stage of the stock option…

Those unvested ISOs...

They go away.

Vested ISOs that you haven’t yet exercised...

You can still exercise after leaving, but only up to a certain point. Your company will give you a set window within which you can exercise any remaining vested options before they expire – oftentimes this is as short as 90 days. If you have more time, know that the options will lose their more tax-beneficial ISO status after 3 months and automatically convert to nonqualified stock options.

Options that you’ve already exercised...

That’s now stock you own outright, so nothing changes there.

If you’re planning a departure from your current employer, be sure to factor in the ISO-related decisions and the associated timeline that will come with the transition. 

A Couple of Special Rules

Early Exercise

Some companies will allow for employees to exercise their options early – even before the vest date. This can be a wonderful opportunity to consider since it creates additional tax benefits, but it does carry additional risk. It also requires filing paperwork with the IRS, called an 83(b) election, within 30 days of exercising.

$100k Limit

While many recipients of option grants won’t have to worry about this, it is necessary to know the total annual value of your ISOs, based on the fair market value of the stock at the time of grant. The IRS doesn’t want people benefiting too much from ISOs (classic), so they have put this limit in place. Simply put… If the value of the shares scheduled to vest in a given calendar year, multiplied by the FMV of the company stock at the time of grant, is greater than $100,000 → any options beyond that threshold are treated as nonqualified stock options instead of ISOs.

Tax Essentials

Ok ok… I know I said taxes will be in a separate post, but some elements are crucial to know from the jump. I’ll expand on these and include more in the follow-up piece. After all, what REALLY sets “incentive” stock options apart from their nonqualified counterpart comes down to the tax treatment.

First off, let’s address when there is a taxable event…

When do taxes apply to Incentive Stock Options

You can easily see how taxes may not come into play at all until it’s time to sell the shares. 

Exercising and Taxes

For many people, there will be no taxes owed when they exercise ISOs – creating an impactful tax advantage over nonqualified stock options. However, for some, exercising could mean paying Alternative Minimum Tax – thus making it critical for everyone to be mindful of what this is. 

AMT is a totally separate tax “system” (Form 6251) than the one most of us are accustomed to (Form 1040). In other words, it is an entirely different method for calculating tax liability for the year. Certain conditions require someone to figure out their tax liability under “ordinary” income tax rules and then run the calculation for the alternative minimum tax. They then have to pay whichever amount is higher for that year. If someone exercises ISOs and does NOT sell them within the same year – this is a condition that requires them to run the AMT calculation. More specifically, the difference between the strike price and fair market value of the stock at exercise (spread) is included as income when figuring AMT liability.

Here’s a helpful AMT calculator.

Tax Treatment at the Time of Sale

To recap where we are: Many people will pay zero taxes on ISOs at the time of grant, vest, and exercise (assuming AMT doesn’t apply). That means that taxes often don’t even enter the equation until the stock is eventually sold, at which point we will assess the impact in one of two ways: “Qualifying Disposition” or “Disqualifying Disposition”.

Qualifying Disposition...

A qualifying disposition means that the shares were held at least two years beyond the date the ISOs were granted AND at least one year past the exercise date. If these conditions are met, then the difference between the sale price and strike price (amount you paid at exercise) will be taxed at the more favorable long-term capital gains rates.

Disqualifying Disposition...

If you fall short of those two conditions, then the sale is considered a disqualifying disposition. In this situation, the tax treatment is less beneficial. The difference between the strike price and the FMV on the date of exercise is taxed at ordinary income rates. Then, the difference between the FMV at exercise and the eventual sale price is taxed at either short-term capital gains (ordinary income) or long-term capital gains rates – depending on how long the shares were held after exercise (Did you hold for one year of less? STCG… Did you hold for more than one year? LTCG).

Wrapping It Up

If you are awarded incentive stock options as part of your compensation package, start with learning the lingo (below!). Then, make sure you understand the life stages of an ISO and the timing of each. This will create a powerful foundation from which you can start building out your strategy. To round it out, familiarize yourself with the tax implications of each possible decision and consider how a given scenario can support your personal financial goals – see Part 2 and 3!

ISO Vocabulary

Incentive Stock option

An option or right to purchase stock in your company at a pre-determined price.

Grant

The award of a set of incentive stock options. A “grant” is typically given to an employee at hire, and/or as comp is adjusted up based on positive performance. Grants usually come in “sets” of ISOs (for example, 100 ISOs).

Exercise

The act of executing your right to buy shares in your company under the rules of your incentive stock option plan. This is the point at which you take ownership of the stock.

Vest

The moment at which you can first exercise your options. ISOs come with a “vesting schedule” – a period of time you must wait before you can exercise. You do NOT have to exercise as soon as the options vest. It is your choice whether or not you exercise and when. However, they will expire at some point, typically after 10 years.

Cliff

Sometimes included at the front end of a vesting schedule. This is a duration of time – immediately after a grant is awarded – during which no options vest. Once this period has passed, the options will begin to vest according to the terms of the grant. A common cliff is one year.

Fair Market Value

The underlying value of a stock. For publicly-traded companies, this is simply the stock price at any given point of time.

409A Valuation

In the context of ISOs, this is the current assessed fair market value of a private company’s stock. With private companies, you can’t simply google the stock symbol to find the price. Instead, you must check with your employer to learn the current 409A.

Strike Price

Also referred to as the “exercise price”. This is the “pre-determined” price at which an employee is able to purchase the stock in their company – under the rules of the incentive stock option grant. The hope is that – at the time of exercise – the strike price is lower than the current fair market value of the stock, meaning there is immediate value in taking advantage of the option to exercise.

Spread

Also referred to as the “bargain element”. This is the difference between the strike price and the fair market value of the company stock on the day of exercise.

Holding Period

The amount of time that passes from the point of exercising (purchasing) your company stock until you sell the stock. In other words, this refers to how long you own (or hold) the stock.

Qualifying Disposition

Refers to the process of selling your company stock (purchased through an incentive stock option plan) that receives more favorable tax treatment on the bargain element at sale. In order to meet the required thresholds, you must hold the stock up until at least 2 years from the date of grant and at least 1 year from the date of exercise. If these thresholds are met (and assuming there is a gain), then any sale from that point forward qualifies for “long-term capital gains” tax treatment (a lower tax rate than ordinary income tax rates). This preferential tax rate is applied to the entire gain – the value between the exercise price and sale price.

Disqualifying Disposition

Refers to the sale of company stock (acquired through an incentive stock option plan) that does NOT receive preferential tax treatment, at long-term capital gains rates, on the bargain element. In this case, the stock is sold before meeting the thresholds outlined above for a “qualifying” disposition. Therefore, the spread (difference between the exercise price and FMV on the date of exercise) is taxed at the individual’s ordinary income tax rate. Any additional gain beyond the spread will still be taxed based on the holding period from exercise. If the stock was sold in one year or less, those additional gains are also taxed at ordinary income tax rates. If the stock was sold more than one year after exercise, then just those additional gains will be taxed at long-term capital gains rates.

In the Money

Means that your incentive stock option is worth something! Put another way, it’s the scenario when your exercise price is lower than the current FMV – meaning that if you were to exercise and then sell right away, you’d make money.

Out of the Money

Means that your incentive stock option is worthless… In this scenario, your exercise price is higher than the current FMV – meaning if you were to exercise, you would be paying more for the stock than it’s actually worth. Subsequently selling it would lose you money.

Alternative Minimum Tax

A totally separate tax “system” (Form 6251) than the one most of us are accustomed to (Form 1040). In other words, it is an entirely different method for calculating tax liability for the year. There are certain conditions that require someone to figure out their tax liability under “ordinary” income tax rules and then run the calculation for the alternative minimum tax. They then have to pay whichever amount is higher for that year. If someone exercises ISOs and does NOT sell them within the same year – this is a condition that requires them to run the AMT calculation.

83(b) Election

Allows for early exercise of options, even before the set vesting schedule, with the potential for more beneficial tax implications. This election simply locks in the “spread” at the date of the early exercise. The hope is that this results in a lower spread, thus reducing or eliminating AMT liability, and starts the holding period clock earlier than would otherwise be possible. The election must be filed with the IRS within 30 days of exercise.

Liquidity Event

A major transition event for a company that creates significant potential value for an employee holding company stock or incentive stock options. Common examples include an Initial Public Offering (IPO) or acquisition. This event creates an opportunity for the stockholder to easily sell their stock for greater value than what it was purchased for – or for an option holder to simultaneously exercise the options and sell the underlying stock for more than the strike price. 

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Fiduciary, fee-only, Certified Financial Planner, Eddy Jurgielewicz

Eddy Jurgielewicz, CFP® is a Partner and Lead Financial Planner at Upbeat Wealth, a fee-only firm based in New Orleans and serving clients virtually across the country. He specializes in providing straightforward financial guidance to ambitious young families as they navigate life’s many milestones.

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Disclaimer: All content in this article is provided for educational, general information, and illustration purposes only. None of the information is intended as investment, tax, accounting, or legal advice. Nor is it a recommendation for purchase or sale of any security, or investment advisory services. We encourage you to consult with a financial planner, accountant, and/or legal professional for advice on your specific situation. Read our full disclaimer here.