Stock-based benefits like restricted stock units (RSUs) or stock options may be a major part of a pay package you’re considering. But it can thrust you into a set of complicated decisions you’ve never had to make before. If you’re faced with a decision between the two, understanding how they work, their potential value and their tax implications is a good place to start and can make the decision easier. But you’ll also need to take into account your current financial picture as well as your appetite for risk.
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What you get when you get RSUs or stock options
RSUs and stock options are types of equity compensation that employers may offer to attract and retain talented employees. The value of these incentives is tied to the company’s stock performance, which helps to align workers’ interests with the company. If the company succeeds, workers holding company stock may also benefit.
With restricted stock units, or RSUs, a company agrees to give shares to the employee over the course of a vesting period, and perhaps after meeting other stipulations. Once the shares vest — typically in batches over several years — ownership of the shares transfers to the employee at no out-of-pocket cost. At that point, the employee can opt to sell or hold the shares.
With stock options, a company promises to sell a certain number of shares to an employee at a set price, known as the strike price. Stock options also tend to have a vesting period. Once the shares vest, the employee has the right to purchase those shares at the strike price. This step is known as exercising your options, and it can occur any time until the options expire (typically up to 10 years after the options are granted).
You may hold incentive stock options (ISOs), nonqualified stock options (NSOs) or a combination of both. ISOs can only be granted to employees and must meet certain statutory requirements. They have certain tax benefits. NSOs can be granted to employees, as well as to non-employees, such as advisors or board directors. But they don’t enjoy the tax benefits of ISOs.
At a glance: RSUs vs. stock options
Consider the key differences between RSUs and stock options.
Restricted stock units (RSUs) | Stock options | |
|---|---|---|
What are the typical stages? |
|
|
Are there upfront costs? | No. Employees receive shares once they vest. | Yes. Employees receive the right to purchase shares at a set price once they vest. |
What is the value based on? | The market price. For example, if you’re granted 1,000 shares that vest when the stock price is $25, your RSUs are worth $25,000. | The bargain element — that is, the difference between the strike price and the market value of the shares at the time they’re exercised. So, if you’re granted 1,000 shares at a strike price of $10, you’d pay $10,000 to exercise all of them. If the stock price was $25 at the time you exercised ($25,000 total), the value of your options would be $15,000. |
How are they taxed? | The market value of the shares is taxed as ordinary income when they vest. You may also be taxed on any capital gains when you sell. | ISOs: Taxes are deferred until you sell your shares, though you may face alternative minimum tax at the time you exercise. If you meet certain holding period requirements when you sell, any profit from the sale may be taxed at the typically lower capital gains tax rate. NSOs: The bargain element is taxed as ordinary income when you exercise. You may owe capital gains tax when you sell. |
Do they expire? | No. Any vested RSUs remain yours, even after you leave the company. | Yes. Options typically must be exercised within 10 years from the date they’re granted. When you leave a company, you may have to exercise any vested options within 90 days. |
How to know which is better for you
Stock options and RSUs each have their advantages and disadvantages. But there could be circumstances in which one is more helpful than the other, says Daniel Messeca, a certified financial planner and co-founder of Craftwork Capital in Alexandria, Virginia.
To know whether to take RSUs, stock options or a mix of the two, you’ll need to assess the actual offer before you, as well as your tolerance for complexity and risk. If you’re concerned that you’ll make the wrong decision, consider getting another opinion from a financial advisor or tax professional who has experience with equity. An outside perspective that takes your full financial picture into account could help you feel more confident about your decision.
Run the numbers
To start, gather the specific details of the plan, including:
- The value of the offer today. Consider how many shares you’d be granted, what the company is worth today and the strike price for the options in the offer. The value of an RSU is the current fair market value (FMV) of the shares while the value of a stock option is the difference between the stock’s FMV and the option’s strike price.
- The vesting schedule. You’ll want to know when you actually gain a right to own or purchase the shares.
- How readily you could sell the shares. In public companies, selling shares is pretty straightforward. But private companies might have additional stipulations or fewer opportunities to sell any stock you acquire. It could make the tax implications more or less attractive. More on tax timing below.
- Whether you hold ISOs or NSOs (or both). This affects how your options are taxed.
- Whether your company offers cashless exercising. Some companies permit employees to exercise their options without paying any upfront costs. Instead, you pay for the shares out of the proceeds of the stock sale.
You may find that the math tips the scales in favor of RSUs or stock options. Maybe the size of each grant or the current value of the company makes one of the offers stand out. Or the company doesn’t offer cashless exercising, and that puts the options out of reach. But it’s likely you’ll need to consider these numbers in light of other, more subjective factors.
Take note of the decisions ahead of you
RSUs follow predictable timelines and require you to make relatively simple decisions.
You’d need to evaluate how vested RSUs would impact your tax bill. The IRS treats the value of your RSUs as supplemental income when they vest, even if you haven’t sold the shares. Typically, when your RSUs vest, your employer will withhold taxes the same way it does for your regular wages. But plan ahead: you’ll need to pay those taxes with cash or by forfeiting some of your shares to cover the tax bill. Plus, sometimes the withholding rate isn’t high enough or the supplemental income could bump you into a higher tax bracket. (Read more on how RSUs are taxed.)
You’d need to decide whether to sell or hold your RSUs after they vest. Because vesting is an unavoidable tax event, it often makes sense to sell immediately. But you may have a compelling reason to hold the shares long-term.
You don’t face an exercise decision with RSUs. RSUs are yours when they vest, which is usually on a rolling basis. That could be advantageous if you’re looking for a potential source of cash to meet your financial goals. “If I'm trying to fund education for my children, I know when an RSU vests, I have the net of those shares, I can sell them right away and pay for school or invest them in another fund,” Messeca says.
On the other side, stock options come with decisions that are objectively more complex.
You’d need cash in order to exercise your options. If your employer doesn’t offer cashless exercise (or you don’t want to sell shares to cover the exercise), you’ll need to pay cash for your shares. Depending on the strike price and the number of shares, that could be a hefty sum.
Similarly, you’d need to plan for taxes. If you hold ISOs, there’s a tax incentive for holding your shares for at least a year after you exercise and two years after they’re granted. You won’t owe ordinary income tax on those exercised options, but you may owe alternative minimum tax. (NSOs are treated differently. For more, see our stock options tax guide.) One advantage of stock options is that you choose when you purchase your shares, which means you have some control over when and how many shares become taxable at a time. That gives you more flexibility to be strategic, if you have the time and capacity to implement a strategy or hire a financial advisor who can do it for you.
You’d need to time your exercise based on these and other factors. For example, you’ll need opportunities to sell your shares, or you’ll have paid money for stock that you can’t earn back. If you work for a private company, selling may not be straightforward.
Determine the level of risk you’re comfortable with
There’s always some risk involved when you agree to receive compensation in the form of company stock. For example, you could decide to leave the company before any of your shares vest. But RSUs and stock options come with different risk-related considerations.
RSUs are relatively less risky because you don’t have to buy the shares. Their value is based on the stock’s current FMV, which can go up and down, but will retain some value unless the share price goes to $0. This makes them a safer bet than stock options if you want your equity compensation to supplement your income.
Stock options become worthless if the strike price is higher than the market price of the shares. And options expire if you don’t exercise by a certain date. That means you could lose out completely if the market price never rises above the strike price.
But if you plan to treat your equity compensation more like an investment opportunity — something you’re not counting on to meet your current goals or day-to-day needs — the reward from options could be worth the risk. That’s why startups and other pre-IPO companies with high-growth potential might use stock options to attract top talent.
“If I'm in the investor mindset and in good shape, doing everything I need to do, maybe I'm more willing to focus my efforts on options because my potential upside is very large there,” Messeca says.
» Is your employer going public? Learn what to do with your stock
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Are you on track for
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NerdWallet Wealth Partners created a free calculator to estimate your financial independence number, see where you stand, and find out how much you might need to close the gap.
NWWP is an SEC-registered investment adviser. Registration does not imply skill or training. The calculator is provided for informational and educational purposes only.
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