Couple Takes Stock of Their Options For a Simpler Life

Based on their lifestyle, you’d never suspect that Brad and Janine Bolon are millionaires--at least on paper.

Janine, 36, hangs the family’s laundry in the garage to shave $30 off the monthly utility bill. Brad, 38, walks to work and often comes home for lunch. So Janine could quit her job as a biochemist and become a stay-at-home mom, the Bolons stopped eating out and scaled back to one vehicle--a 1997 pickup with a camper shell for low-cost vacations. Even with the extra expense of raising Sean, 3, and Beth, 1, the Newbury Park couple manage to save more than a third of Brad’s $118,000 annual salary.

So it’s little wonder Janine earns a few hundred dollars a year as a “frugality consultant.”

“It’s not how much money you make,” she said. “It’s how much money you don’t spend.”

But the Bolons’ penny-pinching can be deceiving. Brad, a research scientist with biotechnology giant Amgen Inc., is sitting on stock options that could be worth as much as $2.3 million by 2005. And while Brad thoroughly enjoys his job developing cutting-edge medical treatments, he harbors an ambitious goal: retiring from Amgen at age 45 to start a new, low-pressure career somewhere in the rural West.

Voluntary early retirement has become a mantra of the 401(k) Generation. And the Bolons’ frugality, combined with Brad’s stock options and their $300,000 in savings, gives the couple a realistic chance of realizing that goal, said Randall Sanada, a certified financial planner in Westlake Village, and Martin Belak-Berger, a certified public accountant in Encino, who reviewed the Bolons’ finances at The Times’ request.

The idea is to use the big money the Bolons are setting aside during Brad’s Amgen career as a retirement nest egg. Freed from having to add to their retirement savings once Brad quits his job, and assuming they continue their modest living standard, the Bolons should be able to shift to a much lower income without suffering financial disaster.

Brad’s stock options, of course, are the key to this blueprint.

Stock options have become a popular way to reward valued employees. They represent the right to buy a specified number of shares of a stock at a set price by a certain future date. Options can be used to buy stock for less than its market price, and the shares can then be sold at a profit. For instance, some of Brad’s options allow him to buy Amgen stock for $13.09 a share, well below its recent price of $70.

After options are awarded, they typically must be held for a certain number of years before they can be exercised--that is, used to buy stock. On meeting that “vesting” requirement, holders usually have a few years to exercise their options before they expire. There’s no deadline for selling the stock, but many options owners sell the day they buy to pay for the stock purchase and to lock in profits.

It looks like easy money, but profiting from options is, well, taxing. Brad’s options to buy 32,951 shares of Amgen are segmented into 11 vesting periods and have five expiration dates. And each transaction--buying, holding and selling--has tax consequences. For instance, in most cases federal income tax must be paid on gains from options even if the holder elects to keep the stock, and the profits are only on paper.

On paper, Brad’s vested options have a pretax value of $842,000, the difference between the options’ exercise prices and Amgen’s recent stock price of around $70. Assuming Brad stays at Amgen through 2004, he’ll meet the vesting--or holding--requirements for another clump of options currently valued at $698,937.

Like some of his co-workers, Brad had planned to wait until 2004, the first deadline for exercising his options, before buying. Holding options until expiration nears is a common strategy that bets on higher stock prices, but it’s too risky for the Bolons, Sanada and Belak-Berger said.

While the two experts share Brad’s optimism about Amgen, they warn that the Bolons are vulnerable to a downturn, either by the company or the stock market. That warning was born out just last week, when Amgen’s shares fell along with other biotechnology issues. About 60% of the couple’s net worth is tied to that one stock. Because Brad’s retirement goal is only seven years away, he should start exercising options this year and use the proceeds to diversify his investments, Sanada said. That doesn’t mean cashing in all at once. The tax bite would be too great.

Sanada and Belak-Berger suggested that Brad unwind his options over five years to moderate income flow and taxation. Their strategy, which assumes Amgen’s stock price will rise 6% a year, is designed to capture profits while keeping a lid on taxes. But even this would push the Bolons from the 28% tax bracket to the 36% bracket, applicable this year to taxable income from $161,450 to $288,350 for couples filing jointly.

“The challenge,” said Belak-Berger, “is to keep them out of the 39.6% bracket,” the highest federal income-tax rate.

The plan is susceptible to many variables, such as the direction of Amgen’s stock price. If the stock plunges, Brad should accelerate his buying and selling to lock in some profits. If the stock were to soar, he’d have to prepare for a higher tax bill.

Moreover, Brad won’t know how much stock to buy via options or how much to sell each year until he knows his exact pay from Amgen, which includes bonuses.

“In any given year, you have to run 30 or 40 projections to find out how much options-holders need to exercise and sell,” Belak-Berger said. “You have to see what gets them to the top of each tax bracket.” This year, for instance, Brad can realize about $200,000 in stock-option profits and still stay in the 36% bracket.

Adding to the complexity is the fact that Brad’s two types of options--incentive and non-qualified--are subject to different tax rules.

Worse still, reaping big profits from exercising his incentive stock option could push the Bolons into the alternative minimum tax, a complicated federal tax system designed to ensure that wealthy people pay at least some tax. Because the AMT income levels haven’t been indexed to inflation and the use of stock options as an employee benefit is spreading, more unsuspecting investors are getting snared by the tax.

Like Brad. Because of Amgen’s big run-up in recent years--its shares have spiked 400% since ‘97--he may have to pay the AMT at some point, Belak-Berger said. He would’ve reduced his taxes by exercising some options earlier, when he was in a lower tax bracket and Amgen’s stock price was lower. Of course, if he had exercised and sold simultaneously, he also would’ve missed some of Amgen’s later gains.

“The ideal situation is to buy the option and wait for the stock to appreciate,” Belak-Berger said. “Remember, exercise just means buy. You don’t have to sell.”

As the Bolons cash in their options, the profits should be invested in a variety of mutual funds, Sanada said. He also recommend making some changes in the Bolons’ current investment portfolio, which is almost 100% invested in stocks and stock mutual funds. About 20% should be allocated to bonds and cash, and their fund portfolio should be diversified as well, with some of the money shifted from index funds to international, growth and small-company funds.

Because the Bolons live modestly and save prodigiously, they can withstand dips in Amgen’s share price, although that could push their retirement date beyond 2007, Sanada said. In addition, their plan to continue working, albeit at modest pay, will act as a safety net, he noted.

And what will those new jobs be? Among the options discussed: park ranger, college instructor, youth mentor and professional volunteer. Whatever their new careers, they want less hectic lives in a less crowded part of the Western U.S.

“Amgen is the best job I’ve ever had,” Brad said. “However, I have other interests--family, self-education and writing books--that can’t be squeezed into a 50-hour-a-week-plus work schedule.”

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This Week’s Make-Over

Investors: Brad, 38, and Janine Bolon, 36

Annual income: About $118,000

Goals: Achieve financial independence in seven years, using Brad’s stock options to fund retirement plan; pursue second careers.

Current portfolio

* Cash and savings accounts: $11,000 in checking and money market accounts

* Real estate: $15,000 equity in Newbury Park townhouse.

* Retirement accounts: $83,000 in Brad’s 401(k) plan, invested in Fidelity stock and balanced mutual funds; $69,700 in Brad’s IRA, $64,500 in Janine’s IRA, $6,800 in Brad’s Roth IRA and $7,500 in Janine’s Roth IRA, all invested in Vanguard stock index mutual funds.

* Other assets: About $842,000 in vested Amgen Inc. stock options; $698,937 in unvested Amgen options; $25,000 in U.S. series EE savings bonds; $12,000 in U.S. Treasury zero-coupon bonds; $5,600 in individual stocks, including Amgen, Cisco Systems, Colgate-Palmolive, Dell, Glaxo Wellcome and Immunex; $8,200 in Vanguard stock index fund; $3,300 in two educational IRAs, invested in Vanguard stock index funds; $4,800 in technology mutual fund.

* Debt: $113,500 first mortgage at 6.625%; $32,000 second mortgage at 4.3% (provided by Brad’s employer).

Recommendations

* Continue modest lifestyle.

* Exercise Brad’s Amgen Inc. stock options over five years to reduce taxes; reinvest in a diversified mutual fund portfolio.

* Diversify existing portfolio to include other types of stock mutual funds, such as international, small company and growth, and move 20% into bonds.

* Save for children’s college tuition using qualified state tuition programs, also known as 529 plans, for tax-deferral and estate-planning features.

* Make charitable donations with Amgen stock.

Meet the experts

* Randall Sanada is a fee-based certified financial planner in Westlake Village. He is president of Alliance Financial Group Inc., a financial-planning practice.

* Martin Belak-Berger is a certified public accountant and managing tax partner of Block, Plant, Eisner, Fiorito & Belak-Berger in Encino.

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Doing the Math on Options

On Aug. 4, Brad Bolon met the vesting requirements for stock options that give him the right to buy 1,700 shares of Amgen Inc. for $14.42 a share. Based on Amgen’s recent share price of $70, here’s how the math works out:

Note: Calculations are for incentive stock options. Non-qualified stock options are always taxed as ordinary income.