Stock-based compensation: How to use your 10b5-1 plan to achieve your financial goals

If your employer provides stock-based compensation, your ability to sell shares could be subject to complex trading restrictions. It can also be difficult to keep track of when lockup trading periods expire and to stay diligent about selling stock at your preferred price and at times that match your liquidity needs. To help avoid these pitfalls, Securities and Exchange Commission (SEC) Rule 10b5-1 provides guidelines for insiders of publicly traded companies to set up trading plans for selling their stock. Read on to find out more about the components and benefits of 10b5-1 plans, how they can be used to help achieve your financial independence goals, and some recent changes to the plans.

What’s a 10b5-1 plan?

Due to the rise of insider trading concerns in the 1990s, the SEC created a rule in August 2000 that established 10b5-1 plans — a useful tool that can provide corporate insiders a defense against insider trading liabilities. A 10b5-1 plan allows insiders to sell shares under a prearranged structure to help avoid SEC-related issues and provide more transparency for sales of their company stock. The plans are often used alongside personal financial plans to sell company stock at regular intervals to diversify an individual’s investment portfolio and build toward reaching their “financial independence number” — the amount of assets needed to support their lifestyle and long-term financial goals. 

The plans are often used alongside personal financial plans to sell company stock at regular intervals to diversify an individual’s investment portfolio and build toward reaching their “financial independence number”.

For employees who are subject to material nonpublic information (MNPI), a 10b5-1 plan can also provide opportunities to execute trades during lockup or restricted trading windows when on-demand trades aren’t allowed.

Who’s a 10b5-1 plan for?

Trading restrictions often apply to executives, directors, or anyone subject to MNPI. If you’re unsure whether you have access to MNPI, ask your company’s internal compliance department or legal counsel for clarification and guidance on compliance procedures.

Terms/features of 10b5-1 plans

The following factors must be specified when creating the plan.

Order type

A 10b5-1 plan must specify whether a market order or limit order is being used to execute trades. A market order is used to buy or sell a specific amount of stock at the current market price. Alternatively, a limit order is only executed upon certain price criteria being met. For example, a limit order might be used when an employee wants to sell 50 shares of stock but only if the price is $30 or higher on a particular date. If the stock price is less than $30 on that date, the employee doesn’t want any shares sold and would prefer to hold onto the stock in hopes it will appreciate in the future. Lastly, stop-loss orders are another way to customize 10b5-1 plans by adding instructions to sell a position if it drops to a certain price, limiting the loss on that stock.

Sale date/window

Stock can either be sold on singular dates specified within the 10b5-1 plan or during periods of time if a limit order is being utilized. Each planned transaction can have its own unique sale date or window. Users also need to consider the required “cooling-off period” for initial sales within the plan.

If using trading windows, it’s important to consider expiration dates around year-end. If a trading window spans across two calendar years (e.g., December 2023 and January 2024), the stock could unpredictably sell in either year, which could inadvertently increase your income and adversely affect your tax planning.

Share quantity

The number of shares to be sold must be outlined in the 10b5-1 plan for each potential transaction. These plans can include stock that hasn’t yet vested, such as restricted stock units (RSUs) that will convert to common stock. However, the stock can’t be sold until the vesting criteria are met. 

The quantity of shares sold can differ depending on the share price of the stock on the predetermined date of execution. For example, an employee’s 10b5-1 plan could establish limit orders for 20 shares of “Stock X” specifying if it hits a share price of $30 on the execution date of March 1, 20 shares will be sold; however, if the price were $40 per share on March 1, the plan could dictate that 50 shares be sold.

The quantity and prices specified by the 10b5-1 plan can’t be changed once the plan is implemented. However, if an employee is no longer comfortable with the terms of the 10b5-1 plan, the plan can be revoked. This is frequently the case for plans with a volatile stock.

Planning considerations

Diversification/risk management

If you receive RSUs, stock options, or restricted stock, or participate in an employee stock purchase plan, company stock can become a large portion of your balance sheet. Executive restrictions on stock transactions can lead to a lack of action that could result in a build-up of a single stock position and subsequent lack of diversification in your portfolio. The risk becomes further magnified if future 401(k) plan contributions, salary, and potentially deferred compensation all depend on your company’s continued success and existence. 

If your financial independence relies on a highly concentrated stock position, it might be a good time to consider how much you should sell to ensure you’ll have enough assets in a diversified portfolio to support your retirement. It may seem as if diversifying isn’t urgent, but the sooner you put a plan in place, the better protected you are from that stock’s volatility. 

A well-designed 10b5-1 plan can help you manage concentration risk by using the various rules and trading windows to sell stock at times and prices that align with your financial plan. The key is to track the amount of exposure to the company on your personal balance sheet and plan your transactions accordingly. A good plan will reduce exposure to your company stock and help take the emotion out of trading; it can serve as a method of “dollar-cost averaging” out of the position by smoothing out exit point prices over time. Liquidated stock can then be reinvested in a brokerage account using more diversified investments. 

Given that markets can be erratic in the short term and a company stock can be greatly affected by the news of the day, stock compensation should be categorized as equity risk exposure when determining appropriate asset allocation targets for your portfolio. If your vested stock becomes a meaningful percentage of your investment assets, it might make sense to lower the allocation to stocks within the rest of your portfolio to ensure your overall personal balance sheet has an investment mix that matches your personal risk tolerance and the risk/return profile that’s needed to achieve your financial goals. This could be accomplished by investing more in safer assets such as cash, money market funds, fixed-income securities, or other alternatives to equities.

Compliance

Oftentimes executives or directors can be subject to a minimum holding requirement as established by the company specifying how many shares they must own to ensure they keep some “skin in the game.” When crafting a 10b5-1 plan, creating a share reserve or matching up sale timing with future vesting dates can help ensure you don’t dip below this threshold. If you’re unsure of whether you’re subject to holding requirements, we’d recommend asking your company’s internal compliance department or legal counsel.

Cash flows/liquidity

When determining the timing of sales, it can be helpful to map out future expected expenses or goals so the sales can provide liquidity when it’s needed. This can also apply to tax estimates that could be necessary as a result of the stock sold using a 10b5-1 plan.

When determining the timing of sales, it can be helpful to map out future expected expenses or goals so the sales can provide liquidity when it’s needed.

The 10b5-1 plan allows for sales to be executed across a multimonth time frame if desired and with pricing caveats if using limit orders. This helps avoid running into situations where you’re potentially forced to sell company stock at a less than ideal price to increase liquidity for upcoming cash needs.

Tax consequences

Coordination with a CPA should take place during the initial creation of the plan, as well as throughout the execution of stock sales. It’s important for the tax preparer to be aware of capital gains realized through the sale of stock, ordinary income events related to exercising options, or other tax consequences from other forms of equity compensation, so that appropriate tax withholding or estimates can be made and so there are no surprises come tax filing time. Appropriate tax reserves or cash flows for these payments should be established or planned.

Coordination with a CPA should take place during the initial creation of the plan, as well as throughout the execution of stock sales.

It’s also prudent to share your plan with the CPA so tax planning can determine whether it makes sense to accelerate or decelerate deductions or other income, such as charitable giving, deferred compensation, Social Security, Roth conversions, or 83(b) elections.

New SEC amendments to 10b5-1 plans

To close loopholes and make 10b5-1 plans more transparent to the public, the SEC adopted amendments that went into effect on Feb. 27, 2023, for new 10b5-1 plans. The changes include: 

• A “cooling-off” period that’s required before trading can begin in the plan.
  • For a director or officer, it’s the later of: 
    • 90 days after the creation of a new plan.
    • Two business days after the reporting of a company’s financial results. The maximum cooling-off period would be 120 days. 
  • For all other 10b5-1 plan users, the cooling-off period is 30 days. 
• A ban on overlapping 10b5-1 plans.
• A limit on users to one single-trade plan per 12-month period. 
• Increased disclosures and reporting by companies issuing stock compensation.

Conclusion

A 10b5-1 plan is a great way to manage your stock-based compensation and align planning with your long-term financial goals. There’s plenty of complexity when it comes to 10b5-1 plans, so working with your financial advisor will help you navigate your options, adjust to the recent changes, and lower the risk involved with owning and selling company stock.