Historically offered at startups and tech companies, restricted stock units (RSUs) are gaining broader popularity alongside stock options in employee incentive plans.
Nike, for instance, gives employees the option of choosing either RSUs, nonqualified stock options, or a 50/50 mix of the two.
If you’ve been offered these options, what should you do?
What are RSUs and nonqualified stock options?
A form of equity-based compensation, RSUs are a grant of units, which, after a vesting period, give employees a set number of shares of company stock. Vesting schedules vary, but typically span four years. Once vested, shares can be sold at any time or held indefinitely—they do not expire.
Nonqualified stock options give employees the right to, after a vesting period, buy a certain number of company shares at a specified grant price. Shares can be held or sold after exercise but the stock options expire 10 years after the date they were granted.
How do RSUs and options compare?
Risk & return
Stock options require an increase in a company’s stock price to have value—RSUs do not.
With options, if the stock price stays at or falls below the price at which the options were granted, your stock options will be worth nothing. With RSUs, so long as a company’s stock price is above $0, your shares will always have some value.
The amount of that value, however, will vary. With stock options, the higher the stock price is above the grant price, the greater your gain. With RSUs, your value is fixed at the stock price at vesting.
Bill Gates commented on this variability in the value of an option when he said, “Either [an employee] can buy six summer homes or no summer homes. Either he can send his kids to college 50 times, or no times.”
As a result, Microsoft now offers the less risky RSU. Other companies, such as Nike, have followed suit.
To account for this greater risk protection, employees typically receive fewer RSUs than stock options. Nike employees, for example, are awarded five times as many stock options as RSUs.
RSUs are taxed as ordinary income at the time they are vested. The amount of taxable income is equal to the market value of the shares at this time.
With stock options, a portion is also taxed as ordinary income—the stock price at exercise less the grant price. Unlike RSUs, though, stock options are not taxed until you exercise the option to own the shares. This means you have some flexibility—you can control when taxes are assessed by determining when to exercise the option.
Which choice is best for you?
To see how your experience with stock options and RSUs might compare, consider three hypothetical employees and their circumstances.
Jeff is 54 and getting ready to retire next year. At Jeff’s company, his stock options continue to vest according to their vesting schedule.
RSUs, however, do not. If he retires with unvested RSUs, he will lose them. For Jeff, that means he will be able to collect the RSUs that vest in year one, but will lose his shares in years two, three, and four.
If he’s comfortable with their greater risk, stock options may be the better choice for Jeff.
Sarah is 38. She recently completed a kitchen remodel and took out a $100,000 home equity line of credit (HELOC) to finance the project.
Sarah has savings in a 401(k), but little elsewhere. To pay off her HELOC, she is relying on her annual bonus.
For Sarah, RSUs are likely a better choice. They offer a more planned and predictable source of income to meet her immediate cash needs. If, instead, Sarah chose options and they had no value at vesting, she wouldn’t have the resources needed to pay off her loan.
Perry is 42. He is making more money than he is spending and has nearly $500,000 saved in his 401(k). He doesn’t have any money in savings, but he also doesn’t have any immediate cash needs.
What Perry doesn’t have are investments outside of his 401(k). He recognizes all his investments are tied up in a retirement account he can’t access without penalty and wants to start building a diversified portfolio.
To create a nest egg that gives Perry more flexibility and certainty, RSUs are his best bet. Once his RSUs vest, Perry can sell them and build a portfolio that takes advantage of the full market’s potential.
We’re here to help
When deciding between RSUs, stock options, or a mix of both, the right answer will vary from person to person. An investor’s goals, risk tolerance, and tax implications are just some of the tradeoffs to consider when selecting the right approach.
If you have questions or would like to discuss your options in greater detail, contact Vista.
As always, we’re here to help.