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RSUs or Options... Which is better for the employee?


Over the past month I have been asked this question more times than I can count and so I thought it was a great topic to write about.  Although they are similar in many ways, they have huge differences that can affect ones decision about which to use, if given the choice.  Many companies have shyed away from Stock Options and towards Restricted Stock Units (RSU) because of a change in tax reporting that requires them to expense employee stock options.  Some companies, like Johnson & Johnson, actually offer both to employees and make them choose which they want. 

What are they?

Stock Options are the right to buy a specific number of shares in the future at a pre-set price (grant price). In general, options vest three years from the date of the grant, and option holders have an additional seven years from the vesting date to exercise them (exercise period).

Restricted Stock Units (RSU) are a grant of units, with each unit, once vested, equal to a share of stock. Company stock is not issued at the time of the grant. However, when RSUs vest, you will receive one share of company stock for each RSU that vests.

Here is table that compares both:

 

Stock Option

Restricted Stock Unit (RSU)

Value Over Time

Options have value if the stock price rises above the grant price, but could have no value if the stock price is at, or below, the grant price.

RSUs will always have value, whether the stock price goes up or down. The value of your award will increase if the price goes up and decrease if it goes down.

Vesting

100% vested after 3 years

100% vested after 3 years

Term

Options expire 10 years after the grant date

RSUs become actual shares on vesting. Then they are yours to hold or sell

Taxation

In most cases options are taxed as income at the time of exercise, regardless of whether shares are sold or held. Taxes on gains also may need to be paid upon subsequent sale of shares

RSUs are generally taxed when they vest

**This is general information and may not be the same for every plan.  Speak with a tax accountant to determine what your taxes will be.**

Which is better?

It all depends on the company the employee works for and the employee’s financial information.  Here are the questions I usually want to find out about the employee and the company before making a recommendation:

About the employee:

  • How high of a risk tolerance do you have?
  • What tax bracket are you in?

About the stock:

  • How stable has the stock performed over the last 3, 5, and 10 years?  Compared to the stock market?
  • How are the fundamentals of the stock right now?
  • How does the sector that the stock is part of look for the future?
  • Are there any pending issues that will help/hurt the company in the future?

If the employee answers that they have a very low risk tolerance then I would never recommend them choosing options, if given the choice.  This is because with an RSU, they are given the right to actual shares not the right to buy shares at a given price.  

Look at Merck (MRK) for example.  Employees were given options as a bonus on March 2, 2001 with a grant price of $75.76.  These options never were worth anything.  By the time the first portion of the options vested, on March 2, 2002, the stock was trading below $65 and would never come back above the grant price.  If the company had given RSUs instead, although they would be worth less than they were when granted, it would have given some return. 

If the employee answers that they have at least a moderate risk tolerance, the above questions would make a difference to which to choose.  Options and RSUs are taxed at different times, so it is important to figure out what your tax bracket is and which would help/hurt you more. 

If after those questions, there isn’t a clear choice, then look at the stock.  If the answers about the stock are that it: has been very stable; has grown steadily over the last 3, 5, and 10 years; isn’t fundamentally very expensive; has strong growth potential in that sector; and doesn’t have any negative issues pending, then it is worth looking into the options plan. 

I personally prefer RSUs because of the limited risk in them.  Yes, there is more upside potential in an option because of the number of options issued compared to the number of RSUs for the same plan.  For example, Johnson & Johnson gives its employees the choice of which they want and will give four options for every one RSU.

I hope this helps explain the complicated bonus plans and which may be best for you.  Please contact me with any questions or comments,

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Comment | 5 years, 10 months ago from King of Prussia, PA