A stock appreciation right, or SAR, is a compensation tool that employers can use to attract and retain key employees. Like non-qualified stock options and incentive stock options, stock appreciation rights allow you to benefit from appreciating stock prices should the company’s stock price increase.

They’re also similar in that stock appreciation rights are issued with a grant date, an exercise price, a vesting date, and an expiration date — but unlike their employee stock option cousins, you are not required to pay the exercise price of the SAR and may only receive the value in excess of the exercise price.  SARs are generally settled in cash, but can also be settled in stock depending on your plan document. This differs in that when you exercise and hold an employee stock option, you receive stock.

The fact that most stock appreciation rights plans leave you with cash instead of company stock may impact your financial plan in a different way than other kinds of equity compensation. Here’s what you need to know to make the most of your opportunity from owning SARs.

How Does a Stock Appreciation Right Work?

Stock appreciation rights look and act very similar to non-qualified stock options. They are granted as part of a compensation package and upon receipt, they’re issued with key dates and figures of which you should be aware:

• Grant Date: The grant date is the date the stock appreciation right is given to you. This date also determines the exercise price.
• Exercise (strike) Price: The exercise price is the market price of the stock on the grant date and it’s used to determine if your SARs are worth anything. If the current stock price is above the exercise price, your SAR is “in the money.” If the stock price is below the exercise price, the right is “under-water.”
• Vesting Date: This is the first day you can exercise some or all of your stock appreciation right. Prior to this date, even the in-the-money value cannot be accessed. Once your SARs vest, you can exercise the SAR and capture the value.
• Expiration Date: This is the last day you can exercise your stock appreciation right. SARs with a prevailing stock price below the exercise price will likely expire as worthless. For SARs with a prevailing stock price that exceeds the exercise price, exercising your stock appreciation rights should be the way to go (in lieu of allowing them to expire).

Your stock appreciation rights at grant may look like something like this:

• Grant Date: January 1, 2021
• Exercise Price: $10
• Number of SARs: 1,000
• Vesting Date: January 1, 2022
• Expiration Date: December 31, 2031

To illustrate the potential value of stock appreciation rights (and disregarding income tax for now), let’s assume that on January 1, 2022 (when your SARs vest), the share price of your company stock is $50. The in-the-money value of your SARs is equal to $40,000. The math is:

GET THIS GUIDE

When it comes to your finances, it's important to understand what you have, what you should consider, and how it can impact your personal goals. This guide is the best place to start.

(Stock Price at Exercise – Exercise Price) * Number of Rights Exercised = In-The-Money Value

($50 – $10) * 1,000 = $40,000

If your stock appreciation rights settle as cash, you will receive $40,000.  If your plan allows for SARs to be settled in shares of stock, you can calculate how many shares you will receive as follows:

In-The-Money Value / Stock Price at Exercise = Shares Received

$40,000 / $50 = 800

In a stock settlement scenario, you will receive 800 shares of stock instead of $40,000 cash.

When your SARs are vested, you generally have one of two options.

1. You can exercise the stock appreciation right (some or all), pay the tax, and receive the proceeds of the sale. Or
2. You can leave the SAR unexercised.

Unexercised stock appreciation rights will be subject to future stock price fluctuations. Should the stock price continue to go up, your SARs will become more valuable. Should the future stock price decrease go down, it’s possible that you can lose some or all of the value of your stock appreciation right.

The decision on whether to exercise or wait is yours.  However, if your stock appreciation rights are in the money, you will want to exercise your right prior to the expiration date.  Otherwise, you risk losing the right to do so and forfeiting the value.

How Are Stock Appreciation Rights Taxed?

The grant of a SAR is a non-taxable event. Like non-qualified stock options, you don’t have to report anything for tax purposes until you exercise.

When you exercise your SARs, the difference between the fair market value at exercise and the exercise price, multiplied by the number of SARs exercised, gets taxed as earned income and is subject to payroll tax. The tax due will likely be paid from the cash generated during the exercise via a tax withholding.

Following our general example above, the amount of taxable income (which will appear on your W-2) is $40,000. If we assume a federal tax of 22% and a payroll tax of 7.65%, your tax liability would be $11,860.

Due to what you owe in taxes on the SARs, the after-tax proceeds from exercising your rights will be $28,140.

Stock Appreciation Rights and Concentration Risk

Again, stock appreciation rights differ from non-qualified stock options in that SARs are often paid in cash. There are some exceptions, and plans that issue stock does exist — but for the most part, exercising SARs will leave you with cash.

Exercising and receiving cash is important because it creates a different impact on your investment allocation and concentration risk than if you exercise and hold non-qualified or incentive stock options and receive the stock. In fact, you could consider SARs that settle in cash as a kind of forced decision to diversify assets, one that may be in your best interest.  To buy additional shares of stock would take an intentional effort on your part. You would need to take the cash you received and buy shares of stock.

There is no guarantee that SARs that settle in cash or stock options that settle in stock is the better answer, however, so you should still work with someone to ensure you allocate your cash wisely after receiving it.

Planning for Stock Appreciation Rights

Stock appreciation rights look similar and operate very similarly to non-qualified stock options. For this reason, many of the planning considerations remain the same.

If you find yourself with SARs, you should begin by asking a few of the following questions:

• How much company stock do I own, and how do SARs fit into this strategy?
• When is the best time to exercise my stock appreciation rights?
• How will the exercise of stock appreciation rights impact my tax return?
• How does this fit into my overall financial and retirement plan?

Many of the answers to these questions will be the same as they are for employee stock options.

A good financial strategy around when to exercise your SARs and what to do with the cash once you exercise is something that should be developed along with your financial plan.

This material is intended for informational/educational purposes only and should not be construed as investment, tax, or legal advice, a solicitation, or a recommendation to buy or sell any security or investment product. Hypothetical examples contained herein are for illustrative purposes only and do not reflect, nor attempt to predict, actual results of any investment. The information contained herein is taken from sources believed to be reliable, however accuracy or completeness cannot be guaranteed. Please contact your financial, tax, and legal professionals for more information specific to your situation. Investments are subject to risk, including the loss of principal. Because investment return and principal value fluctuate, shares may be worth more or less than their original value. Some investments are not suitable for all investors, and there is no guarantee that any investing goal will be met. Past performance is no guarantee of future results. Talk to your financial advisor before making any investing decisions.