The Difference between RSU's and Stock Options

If you work in today’s big technology industry, it is very likely that you are getting some form of stock based incentive, as part of your compensation. The two most common forms of compensation are restricted stock units (RSUs) and stock options. These two programs both offer very nice incentives for employees, but they are slightly different, and should potentially be treated differently. Also, any time that you hold some form of company stock, you should view your exposure to the company from a holistic perspective, to your overall portfolio.

What is an RSU?

RSUs, are awarded to employees at some date, and typically have a vesting period at some point in the future. Often the vesting will be 25% at the current date, and 25% in one year, 25% in 2 years … etc. At the time of vesting, the company buys a share, and gives it to you. In this way, it is much like a cash bonus. And like cash bonuses, the company will withhold taxes at that time of vesting (commonly, they will just keep shares from your award).

For example, you just received 100 RSU’s that have vested. The company stock is $1. You will received 100 shares of your company at $1 = $100 of compensation. Assuming you are in a 25% tax bracket, the company will hold 25 of your shares. Which means you net out 75 shares.

What do you do with an RSU?

You have 2 options with RSU’s … you can either sell them immediately or hold them. If you sell them immediately, since you just paid the taxes on them, and they likely have not appreciated much, you will not have to pay any capital gains taxes, and you will just receive the cash. if you decide to hold them, and they appreciate, then you will have to pay the capital gains on them.

One major advantage of RSUs

They almost always have value, even if the price of the stock has dropped. For the certainty of that value, RSU are commonly deemed more valuable than stock options. Which brings us to …

What is a stock option?

A stock option, gives the holder the right to purchase a stock in the future at a predetermined price. Like RSUs, options are given out as performance incentives, and typically have a vesting period.

For example, you have the option to purchase your company stock in 1 year’s time at $1. If the stock goes up $1.50, then it would make sense for you to purchase the option at $1, because you would have a built in .50 return. If the stock dropped to $.90, you would not exercise the option, b/c you would be better off to buy it on the market for $.90 than through your options at $1.

**Note that exercising the option is a purchase, but not a sale. Which means that you will not pay any taxes at the point of the exercise. You will only pay taxes upon your sale of the stock.

What do you do with an option?

You should have no more than 5% of your portfolio in single stock.

You can either sell it immediately and pay the capital gains equal to difference b/w the current price and the price at exercise. Or you can hold it. There are advantages to holding it for greater than a year, since you will pay the long term capital gains tax (as opposed to short term capital gains, assessed at your ordinary tax rate).

Advantages of options

You have greater control over taxes with options, since you decide when to sell them (and thus when to pay taxes on them). And since they are riskier, companies typically give you more options.

How do options and RSUs play into your overall portfolio?

Most people just let both their RSU’s and options sit and collect over time. They don’t manage them, they don’t sell them, they don’t really think about them until they move to another company, or they grow big enough to force a conversation. This is a BIG problem. From a simple portfolio diversification perspective, you should have no more than 5% in single stock. And your vested options/RSUs are part of your portfolio. If you have 100k sitting in RSU’s or options from your company, you are very likely way over-allocated. Second, you already have plenty of exposure to the results of the company. Just check your bank account every other week, who is making auto deposits?

If you have “new” RSUs just sell them, you won’t (likely) have to deal with any major tax consequences. If you have older RSUs then you will need to check for capital gains exposure, and make sure you factor that into your savings for next year. Since you had to exercise your options, that means, that very likely you have some major capital gains exposure. So beware, when you sell them.

After selling them, increment into a low cost ETF, rinse and repeat next year.