What Are RSUs? Restricted Stock Units and How They Differ from Options
by Sandy John
Restricted stock units, or RSUs, can be a valuable employee benefit as long as you understand the ins and outs of how they work. RSUs can be a more reliable benefit than their better-known cousin, the stock option. In both cases, the company is able to lower their direct compensation costs and the employee gains an additional interest in making sure the business does well.
Restricted stock units are shares of stock your employer plans to grant to you, as long as certain conditions are met. Those conditions, known as vesting, are why these are “restricted” stock units.The most common type of vesting is a requirement that you continue to work for the company for a specified period, often three to five years.
The vesting might be gradual, granting you, say, 25% of the total shares each year over four years. So if the grant is for 400 shares, you’d receive 100 shares after each year you completed with the company. Alternately, the company might use a “cliff vesting” schedule which requires you to work the entire period, then receive all the promised shares. In our example, you’d work for four years, then get the 400 shares. If you left the company before then, you wouldn’t receive any stock.
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Other RSU vesting schedules might be performance based. You would receive the shares after you, your department, or the entire company met certain performance goals.
When you receive the stock, you’ll be taxed on the market value of the shares at the time they’re granted, at your ordinary income tax rate. Your employer might withhold the taxes due, often by taking back the number of shares needed to cover the taxes. Some companies might give you the option of writing a check for the taxes or offer some other payment schedule.
Once the shares are yours, you can do what you want with them. When you sell them, you’ll owe tax on any gains the shares have realized since you received them. If you hold them for at least a year, those gains will be taxed at the lower long-term capital gains tax rate.
No matter how much you believe in your company, your stock holdings in the company should make up just a small portion of your overall portfolio. That may mean that you need to sell some of your stock in order to achieve a more sustainable level of diversity. Having a portfolio that’s too concentrated in your employer’s stock is extra risky: If the business turns, not only will the stock’s value plummet, but you could also lose your job.
Unlike an RSU, which is a promise to give you the stock, an option is simply the right to buy a specified number of the company’s shares at a future date for a predetermined price, called the strike price.
The thing about stock prices is, as you know, they go up and down. Say you get an option to purchase 100 shares at $20 each in five years. That could be a great deal if the stock is selling for $30 or $40 when it’s time to exercise your option, assuming you have $2,000 on hand to purchase the stock with. However, the option could be worthless if the stock price is $15 – you’d lose money on every share you purchased.
With RSUs, on the other hand, the company is simply giving you the shares at no cost to you, so no matter how low the stock price is, you’re still getting something of value, as long as the company continues to exist.
Options do present a tax advantage, depending upon which kind of option you have. With the incentive stock option, you don’t pay any taxes on the stock until you sell the shares. With nonstatutory stock options, the spread, or the difference between what you paid for the stock and the market value of the shares you purchased, is taxed as ordinary income.
If your company grants you RSUs or stock options, you need to understand the details of what’s being offered and how that affects your decisions. Read the plan, and if you have any questions, turn to the HR department or a financial advisor to make sure you get the most out of these kinds of employee incentives.
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