When you take a new job, your salary may not be your only form of compensation. You’ll likely also get benefits, vacation days, and possibly some form of stock in the company. This will likely come in one of two forms: restricted stock units (RSUs) or stock options. Each of these two possibilities has its own benefits and disadvantages, so you’ll want to make sure you know which you’re getting so you can adjust your financial plans accordingly. A financial advisor can help you determine whether stock options vs. RSUs can benefit your long-term financial plans.
What Are Stock Options?
A stock option lets you purchase equity in a company at a determined price within a certain window of time. You do not have any obligation to purchase the shares, but you are given the chance to do so if you think it’s a smart decision. Generally, one stock option contract represents 100 shares of the firm that you are buying into.
The term stock options generally refer to the employee stock option, as described above. You take a job at a company and get the opportunity to buy stock in the firm as part of your compensation. This often involves a vesting schedule, where you have to work at the company for a certain period of time, often one year, before you can purchase the stock. This is to prevent people who only work at the company for a short period of time from ending up with potentially valuable stock.
One of the biggest benefits to stock options is that you get to buy them at a specified price that may end up being much less than what the stock is worth on the market when the option actually vests. The stock options may vest according to a specific schedule. For instance, you may be able to exercise 250 shares per year for a total of 1,000 shares. There may also be an expiration date after which you are no longer able to exercise your right to stock options.
What Is an RSU?
Restricted stock units (RSUs) gained popularity during the 1990s and early 2000s as a straightforward alternative to stock options. Unlike stock options, RSUs do not involve transactions or stock pricing. Instead, they represent a company’s promise to provide employees with stock once specific conditions are met. These conditions might include achieving certain performance goals or reaching a specified tenure with the company.
When the conditions are satisfied, the RSUs are typically converted into actual company shares or their cash equivalent, depending on the stock’s value at that time. The company may decide whether the payout will be in shares or cash, or it might allow the employee to choose.
RSUs usually vest over a set period, often several years. For example, many companies require employees to complete a full year of service before receiving any vested RSUs. After this initial period, it’s common for RSUs to vest incrementally — such as 25% or 20% of the total grant per year — while additional RSUs are awarded each month the employee continues to work at the company.
Stock Options vs. RSUs: Which Is Better?
There are pros and cons to both stock options and RSUs. Your choice will largely depend on your personal preferences, among other factors. Knowing the difference in each major category can give you the right data you need to make a decision. The following is a breakdown of the major differences between RSUs and stock options:
Stock Options vs. RSUs
| Characteristic | RSUs | Stock Options |
| Grant Date | Dated on issuance | Dated on issuance |
| Exercise Price | No exercise price | Set based on the full market value of underlying security |
| Vesting | Can be vested anytime for any milestone | Can be vested anytime for any milestone |
| Payment | Stock or cash | Stock |
| Taxation | Taxed on vested, treated as regular income (capital gains if stock held for more than a year) | Stock options are treated as regular income; ISOs as preferred items for alternative minimum tax |
Other Considerations Regarding Stock Options vs. RSUs
When evaluating equity compensation, the company’s stage is a key consideration. Stock options are often a better fit for startups or early-stage companies that are unprofitable, but have high growth potential. On the other hand, RSUs tend to be more advantageous at larger, well-established companies that are financially stable with predictable stock performance.
Stock options offer employees the chance for substantial gains if the company’s stock price increases significantly over time. However, they come with the risk that the stock price may stagnate or decline, leaving the options worthless.
In contrast, RSUs provide a more stable form of equity compensation. Their value does not depend on the stock price at the time of exercise or sale, making them appealing to employees who prefer predictable income and are less comfortable with market risks.
It’s also important to consider the company’s potential future performance. Stock options only have value if the stock’s market price exceeds the grant price during the vesting period. Otherwise, you could end up paying more for shares than their market value. RSUs, by comparison, represent a net gain, as there’s no upfront cost to acquire the shares — though taxes may be due on the vested shares’ value.
For these reasons, companies often grant fewer RSUs compared to stock options. When deciding which is better for your investment strategy, consider your risk tolerance and financial goals. Stock options can be a worthwhile addition to your investment portfolio if you’re confident in the company’s growth and are willing to accept the associated risks. If you prioritize stability, RSUs may be the better choice.
Taxation for Stock Options vs. RSUs
Taxes are an important factor to consider. Only income taxes apply to RSUs when they’re sold immediately after vesting. This means that you won’t have to pay a capital gains tax at that moment. However, if you sell the shares at a later date, any appreciation over the share market price on the vesting date will get taxed as a capital gain.
On the other hand, two types of stock options exist. These are non-qualified stock options (NSOs) and incentive stock options (ISOs).
For NSOs, you’re taxed on the difference between the market price and the grant price. This is called the spread, and it’s taxed as regular income. This means it’s subject to income tax and payroll taxes, like Social Security tax and Medicare taxes.
The spread on ISOs, meanwhile, isn’t subject to payroll taxes. Instead, it’s a preference item for the alternative minimum tax (AMT) calculation. The alternative minimum tax, which is a parallel tax system separate from regular tax laws, can be complicated, so getting the help of a financial advisor could be a good idea.
Bottom Line
Stock options are when a company gives an employee the ability to purchase stock at a predetermined price at a given time. This may occur on a vesting schedule, where a number of shares become available each year over a series of years. Conversely, RSUs are grants of a stock that a company gives to an employee without any purchase. Employees get these either as shares or a cash equivalent.
Choosing stock options vs. RSUs is a tough decision, as there are positives and negatives to both. Generally, it boils down to the fact that RSUs are less risky, as they don’t involve spending any money to get the stock. However, keep in mind that as an employee receiving either you likely won’t have a choice. It’s important to know what you’re being offered and how it works before you make a decision on your full compensation package.
Tips for Investing
- If your employer is offering you stock options or RSUs, it might make sense to consult with a financial advisor. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area. You can have a free introductory call with your advisor matches to decide which one you feel is right. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- When you think about investments over a long period of time, don’t forget to factor in inflation. SmartAsset’s inflation calculator shows how the buying power of a dollar changes over time.
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