Understanding Chevron's LTIPs: Restricted Stock, Performance Shares & Stock Options

After years of building your career at Chevron, climbing the ladder to specific salary grades is a significant accomplishment. However, for participants in salary grades 26 (PSG-26) and above, compensation structures become more complicated as Chevron's long-term incentive plans, such as restricted stock units, performance shares, and stock options come into play. We commonly hear from the Chevron professionals we work with that these awards are confusing, and they lack clarity on how the plans are taxed. At Willis Johnson & Associates, we work to simplify these complex benefit plans so families can make well-informed choices for their financial future. Let's dive into these plans one by one.

What Long-Term Incentive Plans Does Chevron Offer?

Chevron's Long-Term Incentive Plans (LTIP) play an integral role in retaining top talent at the company. The LTIPs we'll discuss today are considered "stock compensation," which means an employee receives allocated company stock as the compensation in each plan. Many of these LTIPs reward employees when the company reaches specific goals and are paid out on a predetermined time horizon and vesting schedule.

• Restricted Stock Units (RSUs): Compensation in the form of company shares that an employer gives to employees on a predetermined vesting and distribution schedule.
• Performance Share Units (PSUs): Compensation in the form of company shares given to higher-level professionals such as executives and managers for reaching specific benchmarks for company performance.
• Stock Options (SOs): Compensation in the form of company shares where the recipient has the opportunity to purchase company shares at a predetermined price rather than the current market price.
  
  

Chevron Restricted Stock Units (RSUs)

How Do Chevron Restricted Stock Units Work?

At Chevron, the restricted stock units are one of the simplest forms of stock compensation employees may receive. For employees in PSG-26 and above, Chevron gives restricted stock units to provide a stronger link between employee compensation and company performance.

The payout value of an employee's RSUs is calculated using the following formula:
Chevron RSU Formula: # shares vested * Closing price of CVX

Grant – When Chevron awards an employee the stock

Let's consider an example to describe how RSUs work. April, recently promoted to PSG-26, was granted 220 shares of RSUs in January of 2021.

Vest – The period shares are held, not sold, before being treated like ordinary stock

After Chevron grants RSUs to employees, the employee must hold the RSU for a 5-year vesting period. During this time, the employee cannot sell the RSU. When the vesting period ends, the RSUs are paid out in cash within the account the stock is held in.

To continue our example, April's 220 shares vest from January 2021-January 2026.

Let's presume that on January 1st, 2026, Chevron stock is trading at $150/share. Chevron would calculate April's RSU payout according to the formula above.

220 Shares Vested * $150 per Share = $33,000 (minus withholdings) for her payout.

How are Restricted Stock Units Taxed?

Restricted Stock Units from Chevron are taxed at the employee's ordinary income tax brackets when the RSUs vest, not when they're granted. Additionally, the FICA withholdings applied to your salary and other compensation applies to RSUs at vesting.

Taxes are realized when RSUs vest, not when they are granted.

Chevron Performance Share Units (PSUs)

Stock movement may not always align with business performance. With ongoing market volatility and the transition to green energy, many energy companies are shifting how they structure employee stock compensation. These changes make it so payouts are based on more than just a company's stock performance.

As an incentive to keep top talent at Chevron, performance share units (PSUs) provide a stronger link between employee compensation and company performance.

How Does Chevron Calculate Performance Share Units?

While RSUs use stock price at the date of shares vesting to determine the payout value, the formula for PSUs differs. For example, Chevron calculates performance share units using the 20-day average stock price rather than a single date. The company applies a "Performance Share Multiplier" to determine the final payout amount.

Chevron's PSU Formula:
# shares vested * 20-day Average CVX price * Performance Share Multiplier (PSM)

The Performance Share Multiplier Chevron, as published in January 2021, is a weighted average of two criteria:

1. 70% of the PSM is determined by how well Chevron's total performance compares relative to its peers (i.e., BP, Exxon Mobile, RD Shell)
2. 30% of the PSM is determined by Chevron's efficiency and profitability with capital spent relative to its peers

When looking to understand the PSU calculation, the critical difference is that other factors such as company performance impact the final payout. Ultimately designed to increase employee productivity, the payout for PSUs isn't affected solely by share appreciation but includes factors impacted by the employee's efforts.

How Do Chevron Performance Share Units Work?

Grant

PSUs are granted similarly to RSUs ⁠— Chevron gives them to employees upon reaching PSG-26. Let's continue our example from earlier to highlight fundamental differences between the two plans.

Upon reaching PSG-26, April was granted 440 shares of PSUs in January of 2021.

Vest

You'll recall that RSUs vest for five years. However, it's important to note that PSUs have a 3-year vesting period. During that time, employees can't sell the stock. Similar to RSUs, the payout for PSUs is always in cash rather than actual CVX shares.

Suppose she remains employed at Chevron through December 31st, 2023. In that case, April will receive a total cash payout based on her 440 shares, the 20-day average CVX price, and the PSM.

How are Chevron’s PSUs Taxed?

We discussed above that RSUs are taxed at vesting; however, PSUs are more complex. Like her restricted stock units, April didn't owe taxes on her performance share units when Chevron granted them in January 2021. Instead, she will pay ordinary income and FICA taxes on the PSUs when they're fully vested and paid out.

Chevron typically pays out PSUs two and a half months following the end of the performance and vesting period, so typically, this means February following the last date of the vesting schedule.

For our example, April would receive her vested payout in February 2024. Her full payout amount is subject to ordinary income and FICA taxes, and federal income taxes are withheld from her grant payouts.

Chevron Stock Options (SO)

How Do Chevron Stock Options Work?

Stock options are the most complex of Chevron's long-term incentive plans covered in this article.

Stock Options provide a way for employees to participate in the company's stock growth (or lack thereof). The initial idea was to align company performance with employee compensation. If the company does well, you will do well and vice versa.

There are two types of stock options: Non-Qualified stock options & Incentive stock options. Most Chevron employees receiving stock options will receive Non-Qualified Stock Options (NQSO), so this article will focus on these.

Grant

Continuing our earlier example, after becoming a PSG-26 Chevron employee, April received a notice informing her of her Stock Option Award.

In January 2021, she was granted 1,600 stock options with an exercise price of $88. Her stock options must vest for three years and expire ten years after the grant date (January 2031).

Vesting

Something unique about stock options is the prorated vesting. While the other LTIPs we've discussed vest all at once, stock options vest on a prorated basis for each year in the vesting schedule

For example, one year from the grant date (January 2022), 33% of April's options will vest and become free from restrictions. Another year down the road (January 2023), another 33% will vest. Finally, in January 2024, the remaining 33% of her options will vest.

Exercise – When an employee can purchase shares at a predetermined price

To exercise shares simply means purchasing shares (or exercising your rights to buy shares at a predetermined price). This predetermined price may be a discount to present market prices. The ability to purchase shares at a potentially significant discount is among the key benefits stock options offer compared to the other incentive plans we've discussed.

As April's 533 shares vest each year, she can decide whether or not to purchase those shares. Recall that her agreed-upon exercise price was $88/share.

[Current share price – exercise price] * the number of vested shares = value from the stock option!

Let's suppose that after her 533 shares vest in January 2022, April wants to exercise her option while Chevron shares are trading at $120 each. By exercising her right to purchase those shares at $88 per share instead, she's receiving an additional $17,056 in value!

Methods of Exercise
Chevron offers four methods to exercise stock options.

1. Same day sale
2. Sell-to-cover
3. Cash exercise
4. Stock Swap

Each exercise option has its advantages and disadvantages beyond this article's scope. However, it may be worthwhile to discuss each option with an advisor who understands the complexity of each one to determine the right strategy for your situation.

Upon exercising shares, April has one final decision to make. She needs to decide if she will hold her Chevron shares or immediately sell them.

Sale

Suppose she immediately sells her Chevron shares after purchase. In that case, she will be taxed at ordinary income rates on the difference between the market value price at purchase and her exercise price.

Instead, suppose she holds the shares for a year. When she sells the shares, the difference between the market value price on the day she sells and the market value price on the day she exercised the option will be taxed at long-term capital gains.

Understanding how stock options are taxed is critical to minimizing taxes long-term and could be the difference in paying 40.8% vs. 23.8% in taxes!

Let's consider what happens after all of April's shares vest, and she purchases the shares at the exercise price of $88 per share. As a high-income earner at Chevron, she's in the upper tax brackets, 40.8% for ordinary income and 23.8% for long-term capital gains. The market value of the shares when she exercises them is $120 each, so she's receiving a substantial discount.

Suppose the market value of those shares increases to $160, and she held them for less than a year. In that case, she'll be taxed at her ordinary income rates, which will result in approximately $26,112 of tax paid on the sale. However, if she decides to hold onto the shares for at least one year and the shares increase to $160 each for a sale price, she'll be taxed at her long-term capital gains rate of 23.8% and will only pay $15,232 in tax.

Simply by waiting one year to sell her shares, April can save over $10,800!

How Are Stock Options Taxed?

There are two taxable events associated with stock options: At exercise and the sale.

1. At Exercise: The difference between the market value and exercise price is subject to Ordinary Income + FICA taxes
2. Sale: The difference between the market value at exercise and sale is subject to either Short Term or Long-Term Capital Gains rates (described above)

Given all this information, you may be asking:

• When is the best time to exercise my stock options?
• Should I always hold stock options to capture long-term capital gains, or are there times it makes sense to sell immediately?

Determining the right time to exercise and sell one's non-qualified stock options is the key to maximizing the value of your benefit.

What to Consider if You Receive Stock Options

There are a few crucial elements to review before exercising, holding, or selling your stock options.

Option's Leverage

Stock options are unique in that they have embedded "leverage," which means small changes in the stock price can disproportionately affect the value of the option. Therefore, consider the amount of leverage associated with each one before exercising a stock option grant.

Projected Taxes

Another unique element to consider with stock options is the tax planning opportunities they provide. You can defer paying taxes on the spread before your stock options' expiration by simply not exercising. This flexibility opens the door for strategic planning opportunities to increase the after-tax value of your options.

Diversification

Accumulating Chevron stock over several years can overweight your portfolio with a concentration in energy. However, exercising your options too soon eliminates any upside leverage. The key to determining when to exercise is understanding the options' Insight Ratio.

Understanding how to calculate and interpret an options' Insight Ratio is complex, but it's something we frequently discuss with our Chevron clients based on their risk tolerance and overarching financial goals.

Financial Planning Considerations for Chevron Professionals with Long-Term Incentive Plans

If you have any of the incentive plans discussed in this article, it's critical to have a plan in place to leverage them to their full potential so you don't leave any money on the table. A few of the topics we often discuss with Chevron professionals with RSUs, PSUs, and SOs are: 

Ensure Proper Tax Withholding

Chevron automatically withholds 22% from each grant upon vesting for taxes. However, this withholding amount may not be appropriate for your financial situation. Therefore, it's essential to ensure you withhold the right amount to avoid overpaying or underpaying and being subject to a penalty.

Tax-Efficient Planning for High-Income Years

When many of these stock compensation awards vests, they can create significant bumps in your income. Tracking your awards each year and knowing when they vest allows you to plan and use financial planning strategies to reduce your taxable income.

Don’t Sit on the Cash

Lastly, having a plan for what you will do with the vested cash payouts is paramount. Unlike many other energy companies, Chevron pays out the value of performance share units and restricted stock units in cash (net withholding for tax purposes) rather than stock.

Often we see folks accumulate large cash reserves, which lose purchasing power over time because of inflation. Intentionally investing the cash from these benefits rather than letting them sit in cash could have a substantial financial impact.

Revisiting our example, let's assume April continued to receive 220 & 440 shares of RSUs & PSUs, respectively, and the market close at each vesting date is $120 per share. She withholds 30% for taxes and sees an 8% annual rate of return. If April lets the funds sit in cash, she'll accumulate $430,560. However, if she invests those funds for ten years, she'd have $560,608 invested – that's an additional value of over $130,000!

What Happens with Your LTIPs After Leaving Chevron?

Many Chevron professionals we work with ask us what happens if you leave Chevron before the vesting date of your awards due to severance or retirement. Like many instances in financial planning, it depends. The answer is slightly different for stock options, performance share units, and restricted stock units. Unsurprisingly, each depends on a predetermined formula from Chevron.

Typically, Chevron will look at factors including your age, years of service, and the reason for leaving to determine if you will receive a full or partial payout of your unvested awards. Timing your retirement from Chevron can significantly impact the value you receive from your long-term incentive plans. Working alongside an advisor who understands the nuances and rules of your Chevron benefits can be a crucial component of ensuring you don't leave any money on the table.

Working with a Financial Advisor with Expertise in Chevron Employee Benefits

Our WJA advisors understand the ins and outs of Chevron benefits to help you make the most of what's available to you. Whether you're trying to exercise your non-qualified stock options at the right time or need a diversification strategy out of Chevron stock upon vesting, our advisors can help you avoid common mistakes that can have substantial long-term tax impacts. Schedule a free consultation with our Chevron experts if you're interested in learning about the right choices for your financial scenario with your LTIP awards.