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 navigate both your employee stock options and 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 if you think it is 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 (RSU) came into vogue in the ’90s and early 2000s. They are a bit simpler than stock options in that there is no transaction or stock pricing involved. Instead, the company simply commits to giving an employee stock in the company when a certain requirement is fulfilled. RSUs can be awarded for meeting performance requirements or for being at the firm for a set length of time.
Once you’ve met the requirements, the company will give the RSUs either in actual shares or the cash equivalent based on what the stock is worth at that point. The company may dictate whether the employee gets actual stock or the cash equivalent. Or, it may be up to the employee to decide.
RSUs typically vest over several years and it is common for an employee to not receive anything until they have been working at a company for a full year. After that time period, many have structured the RSUs where they vest 1/4 or 1/5 of the total amount of RSUs granted, and then more RSUs are granted each month the employee remains at the business.
Stock Options vs. RSUs: Which Is Better?
There are both pros and cons to stock options and RSUs. Your choice will depend largely on your personal preferences, as well as a few outside factors. Understanding the difference in each major category can give you the right data you need to make a decision. Here’s a breakdown of the major differences between RSUs and stock options:
|Stock Options vs. RSUs|
|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|
An important factor to consider is how you think the company will be doing in the future. Stock options are only valuable if the market value of the stock is higher than the grant price at some point in the vesting period. Otherwise, you’re paying more for the shares than you could in theory sell them for. RSUs, meanwhile, are pure gain, as you don’t have to pay for them.
For this reason, companies tend to offer fewer RSUs than traditional stock options. If you have to choose, think about whether you want to risk the share prices getting high enough to make taking the risk on stock options worthwhile or if you prefer the relative safety of RSUs.
Taxation For Stock Options vs. RSUs
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 are taxed on the difference between the market price and the grant price. This is called the spread, and it is taxed as regular income. This means it is subject to income tax and payroll taxes, like Social Security and Medicare.
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 a financial advisor’s help may be a good idea.
The 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 qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. 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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