Starting capital is a great retirement plan, if you can pull it off

Nearly two years ago, Trevor Ford left a job at Lending Tree that gave him a 401(k) plan and a generous employer contribution to work on Yotta, an online banking app.

When Mr. Ford started working there, Yotta, like many early-stage startups, did not offer its employees a 401(k) plan. Instead, Mr. Ford received stock compensation in the form of incentive stock options, which entitle him to purchase company stock at a discounted price. He believes that owning seed-stage equity provides a better opportunity to build wealth than an employer-sponsored 401(k) plan with matching contributions.

“Equity could be worth seven figures, hopefully, and maybe more,” said Ford, 33, of Austin, Texas. “That’s more than enough to retire.” But Mr. Ford’s capital will only be worth it if Yotta becomes a successful public company. (Yotta recently gave employees access to a 401(k) but doesn’t match their contributions; Mr. Ford makes a small contribution.)

Trading a corporate job with a traditional 401(k) plan for a job at a new company that offers stock gives employees a unique opportunity to get paid big at a young age. While the potential benefit may be much higher than with a traditional retirement plan, the principal is worthless until someone buys it or the company goes public.

“In terms of building wealth, investing in a 401(k) is like running a marathon, while investing in company stock is like running a race,” said Jake Northrup, certified financial planner at Experience Your Wealth in Bristol, RI, which specializes in helping millennials manage their stock compensation. “If a start-up company hits a home run, they may be able to achieve financial independence at a very young age through their company equity,” added Mr. Northrup. He estimates that about 20 percent of his clients have received some type of principal payment.

Mr. Ford relies on equity in part because he witnessed his friend Andy Josuweit, the founder and CEO of Student Loan Hero, receive a large payout when LendingTree acquired the startup for $60 million in cash in 2018. “A At 31, he walked away with a life-changing amount of money,” Ford said.

Not all startups are successful, of course. An analysis this year by CB Insights, a firm that studies venture capital and startups, found that 70 percent of startups fail.

“You have to keep in mind that it may not work,” said Chris Chen, a certified financial planner at Insight Financial Strategists in Lincoln, Massachusetts. “When you’re in your 20s and 30s and you work in a new company, it seems like time is endless, but at one point or another, you’re going to have to retire,” Mr. Chen said.

Annie Fennewald was among the first twelve employees of a fast-growing technology company in Missouri, and she worked there for almost seven years. In May, after selling her shares through a private equity sale, Ms. Fennewald, 44, was able to retire some eight years earlier than she had planned.

Although she received a seven-figure payout, Ms. Fennewald said she did not trust her capital as her only retirement plan.

“I always treated stocks like a lottery ticket,” he said. “It could be valuable, but I didn’t really put my retirement into it.” When the company began offering a 401(k) plan four years ago, she contributed the maximum amount. Often, as startups abandon seed funding and grow to 50 or more employees, they will offer a 401(k).

But not everyone can sell their capital.

Danielle Harrison, a certified financial planner in Columbia, Mo., has a client who wants to retire but is waiting for her company to go public so she can collect nearly $2 million in principal. “It’s hard to completely rely on something like that,” said Ms. Harrison, owner of Harrison Financial Planning.

If you’re an employee of a new company considering giving up a more traditional route of saving for retirement in favor of relying on capital, here’s what you need to know.

Stock-compensated employees are typically given several thousand shares of stock that they can purchase at a discounted price before the company goes public. If they leave the company, they typically have 90 days to purchase their options. For example, one of Mr. Northrup’s clients worked at a start-up company and had 65,000 stock options that vested at 13 cents per share. His client paid $8,450 to exercise those options.

The company’s shares are now valued at more than $25, making those shares worth $1,625,000, if the company has an initial public offering or is acquired, Northrup said.

“The option you have when you leave is to buy the equity and hope that at some point something happens,” said Jessica Little, 32. She and her husband, Matt Little, 40, have worked at several early-stage companies. -ups and they normally buy their capital when they leave. That investment has paid off several times over, Little said.

However, exercising shares and buying shares is not risk free. There is no guarantee that you will see that money again or that you will receive a payment on your investment, and the value of shares may fluctuate.

Exercising options also has tax implications. “One of the reasons people don’t exercise their options is because it could cost millions of dollars in taxes,” said Jordan Gonen, co-founder and CEO of Compound, a wealth management platform that helps people with equity capital. company to manage your assets. long-term financial health. Those taxes must be paid even before any profits are made on the investment, Gonen said.

The need to have cash to buy stock options and pay taxes on that purchase is why many people who work at startups are reluctant to tie their money to traditional retirement vehicles like a 401(k) or Roth IRA, neither. fully accessible without penalties until later in life, Northrup said.

The mistake some people make is to become so attached to the company they work for and its stock that they don’t want to give up their capital for fear of missing out on a big payout, Chen said. “When you have capital and your salary is tied to the same company, you already have too many eggs in one basket,” Fennewald said. For some, this concern has taken on a new urgency, given the recent drop in startup sales and initial public offerings, which fell more than 80 percent in the first half of this year, according to figures released this week.

Both Mr. Chen and Ms. Harrison recommend saving money in multiple accounts, including a Roth IRA and a health savings account.

Many startups have high-deductible health care plans, so opening an HSA is a great way to get a triple tax advantage, Ms. Harrison said. The money is contributed to the account tax-free. The money held there isn’t taxable, and when you take money out to pay for a health care expense, it’s also not taxable.

After employees max out a Roth IRA and HSA, Mr. Chen and Ms. Harrison recommend that they open a taxable brokerage account that allows them to invest in stocks and bonds.

“If you’re young and you’re 20 to 30 years old before you need that money, you can invest in the stock market,” Mr. Chen said. A brokerage account might be a better investment plan if you’re young, he said, because if you take money out of a 401(k) or Roth IRA before age 59½, it will be taxed as income (with a few exceptions). But if you put money into an S&P 500 index fund and take it out after a year or more, it will be taxed as capital gains, which, at a rate of 15 percent, is generally lower than the income tax rate. said. .

Mr. Ford was working at Student Loan Hero when it was acquired in 2018 and, because he had equity, he received nearly $200,000. After paying off his student loans and opening a Roth IRA, he opened a brokerage account.

After Mrs. Little and her husband used some of their equity to pay off student loans, they spent the rest to purchase property, including a lakeside home in Maine. “We see it as a retirement investment that we are actively enjoying today,” said Ms Little, who is the chief of staff at Catch, an app that helps users save for retirement by depositing a percentage of their income. in an IRA “The return on those investments will be significantly more valuable in the long run than if we had funds wrapped up in a 401(k),” Ms. Little said. Her husband also works at Catch, and they both contribute to Catch’s 401(k) offerings, though they don’t want all their money there until retirement.

“Most young people don’t think about retirement or benefits the same way their parents and grandparents did,” Ms. Little said. Mr. Ford admitted that he didn’t think about retirement often and that most of the people he interviewed for jobs at Yotta didn’t either. “Retirement benefits are not a deciding factor,” he said.

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