RSUs vs Stock Options
As more and more companies add equity compensation as part of their salary packages, high earners like you should understand the difference between Restricted Stock Units (RSUs) and stock options.
What Are RSUs?
RSUs are a promise from your company to give you shares of stock at predetermined dates in the future, if you meet certain criteria. This can be a length of time with the company or meeting a performance goal.
Unlike stock options, RSUs have value as long as the company's stock has value. If your company's stock is worth $100 when RSUs are granted and drops to $50 when they vest, you still receive shares worth $50 each. (The grant date is normally when you are hired and accept your RSUs, and the vest date is when your shares are actually available to you).
RSUs vest according to a predetermined schedule. Some common vesting schedules are:
Cliff vesting: All shares vest at once after a certain period (e.g., 100% after 3 years)
Graded vesting: Shares vest in increments (e.g., 25% each year for 4 years)
Monthly vesting: Shares vest in small amounts each month after an initial cliff period
Once vested, you can sell them or hold them. Most companies automatically sell a portion of vested shares to cover tax withholdings, giving you the net shares.
The main advantage of RSUs is their predictability. You know exactly how many shares you'll receive and when they'll vest.
What Are Stock Options?
Stock options give you the right to purchase company shares at a predetermined price (called the "strike price") for a specific period (usually 10 years).
There are two main types: Incentive Stock Options (ISOs) and Non-Qualified Stock Options (NQSOs).
With stock options, you only profit if the company's stock price rises above your strike price. For example, if you have a $50 strike price and the stock is trading at $100, you can buy shares at $50 and immediately sell them at $100, getting a $50 per share profit.
Timing is one of the biggest factors in stock options. Ideally, exercising stock options would work like the above example but it can be risky waiting until optimal profit while also staying within the time limits of your strike price.
Even if there is a profitable opportunity, some employees struggle to buy large amounts of stock at a “low” price due to concentration risk or not having enough liquid cash.
Advantages and Disadvantages
RSU Advantages:
As long as the company has value, your RSUs have value.
Simplicity: No exercise decisions, strike prices, or expiration dates. RSUs automatically convert to shares (or cash equivalents) on vesting dates.
Immediate liquidity: You can sell shares immediately upon vesting. There's no need to come up with cash for an exercise.
Predictable timeline: You know when you'll receive shares, helping with decisions like home purchases or retirement planning.
No upfront costs: RSUs don't require you to pay anything to receive the shares.
RSU Disadvantages:
Your gains are directly tied to stock appreciation from the vesting date, not the grant date. If a stock is worth $50/share on your grant date and jumps to $100/share on a vest date, you’d benefit from any future appreciation but not the $50 increase that already occurred.
Immediate tax burden: RSUs are taxed as ordinary income upon vesting, regardless of whether you sell the shares. This can create cash flow challenges if you want to hold the shares but need cash for taxes.
No control over timing: You can't choose when to recognize the taxable event because the IRS considers RSUs income when they vest.
Stock Option Advantages:
If your company's stock appreciates significantly, options can provide larger returns than RSUs.
You have some control over when to trigger taxable events through your exercise timing decisions.
Companies often grant more options than RSUs because of their uncertain value.
You can choose whether, when, and how many options to exercise based on your financial situation and market conditions.
Stock Option Disadvantages:
Options can expire with no value if the stock doesn't appreciate above the strike price.
Options require active management, understanding of tax implications, and strategic exercise decisions.
Expiration dates create urgency that can lead to poor decision making. Or, if you wait too long, you might be forced to exercise during unfavorable market conditions.
Alternative Minimum Tax (AMT) risk: ISOs can trigger AMT liability, creating unexpected tax bills even when you don't sell the stock.
Tax Implications
RSU Tax Treatment:
RSUs are taxed as ordinary income when they vest, based on the fair market value of the shares on the vesting date.
Your employer will withhold taxes from your RSU vesting, but this might not cover your full tax liability if you're in a high tax bracket or live in a high-tax state.
Many companies use a "sell-to-cover" approach, automatically selling enough shares to pay the tax withholding and giving you the remaining shares.
If you hold the shares after vesting and sell them later, any additional gain or loss is treated as capital gains. You'll qualify for long-term capital gains treatment if you hold them for more than one year after the vesting date.
Example: You receive 1,000 RSUs that vest when the stock is trading at $100. You recognize $100k of ordinary income, so you’re in the 32% federal bracket and pay (estimating) 10% state taxes, plus payroll taxes. In that case, your total tax bill might exceed $45,000. If the company sells 450 shares to cover taxes, you'd keep 550.
Stock Option Tax Treatment:
In general, stock options give you more control over timing, so, you could spread exercises across multiple years to manage tax brackets or exercise options in low-income years (job transitions, sabbaticals). Beyond that, their tax treatment depends based on whether you have ISOs or NQSOs.
NQSOs:
When you exercise, you pay ordinary income tax on the difference between the exercise price and fair market value. That amount is called the "bargain element."
Your cost basis in the shares becomes the fair market value on exercise date. Any appreciation or depreciation is taxed as capital.
Example: You exercise NQSOs with a $25 strike price when the stock is worth $75. You pay ordinary income tax on $50 per share immediately. If you later sell the shares at $100, you pay capital gains tax on the additional $25 per share appreciation.
ISOs:
ISOs receive preferential tax treatment if you meet certain holding period requirements. There's no tax upon exercise, but the bargain element may trigger AMT.
To qualify for long-term capital gains treatment, you must hold ISO shares for at least one year after exercise and two years after the original grant date.
However, there are annual limits on how many ISOs can be granted ($100k limit based on strike price).
How do RSUs and stock options affect my overall financial plan?
Diversification:
Equity compensation creates concentrated positions in your employer's stock, which violates basic diversification rules.
If your equity positions are underwater, consider tax-loss harvesting to offset gains from other sales.
For concentrated positions that you can't immediately sell (due to lockup periods or tax considerations), consider hedging strategies like protective puts or collars.
Cash Flow:
RSUs have more predictable cash flow thanks to automatic tax withholding, but that reduces your immediate proceeds. Plan for your actual cash receipt to be less than the gross value due to taxes.
More active cash flow planning is required for stock options. You need cash for exercise costs (strike price × number of shares), tax payments on the bargain element (for NQSOs), and potential AMT liability (for ISOs).
Estate Planning:
If unvested, RSUs usually don’t transfer to heirs and are forfeited upon death. However, some companies have policies that accelerate vesting upon death or disability.
Stock options usually have complex rules around death, with some expiring quickly and others accelerating. ISOs may lose their favorable tax treatment if transferred to heirs.
Retirement Planning:
Large equity compensation packages might allow for earlier retirement, but don’t count on unvested grants when making retirement decisions.
RSU income counts toward Social Security wages, potentially increasing your future benefits but also triggering Social Security taxes.
High equity compensation income might push you above 401(k) contribution limits or into higher tax brackets where Roth contributions make more sense.
Advanced Strategies
83(b) Elections
While not applicable to standard RSUs, some companies grant restricted stock where an 83(b) election might be beneficial. This lets you pay taxes on the grant date value rather than vesting date value, potentially converting future appreciation to capital gains treatment.
Donor-Advised Funds
Donating appreciated equity compensation shares to DAFs allows you to avoid capital gains taxes while getting a charitable deduction.
Section 1202 Qualified Small Business Stock
If your company qualifies, some of your stock options or RSUs might be QSBS eligible, which can provide federal tax benefits on sale.
RSUs and stock options each have their own advantages and disadvantages.
RSUs may be preferable if you:
Value predictability and guaranteed value from your equity compensation
Prefer not to manage complex exercise decisions and tax planning
Are risk-averse and want downside protection in your compensation
Don't have significant cash available for option exercises
Work at a more mature company where dramatic stock appreciation is less likely
Stock options may be better if you:
Believe in your company's growth potential and want maximum upside participation
Are comfortable with risk and complexity in exchange for higher potential returns
Have cash available for exercises and tax payments
Want more control over the timing of tax events
Work at an earlier-stage company with significant appreciation potential
As always, we recommend working with a tax professional who understands both tax strategies and wealth management.
Questions answered in this article:
What is a stock option?
What is an RSU?
What are common vesting schedules for RSUs?
·What is cliff vesting?
What is graded vesting?
What is monthly vesting?
What does a “strike price” mean in relation to stock options?
How many types of stock options are there?
What are Incentive Stock Options?
What are Non-Qualified Stock Options?
What are the advantages and disadvantages of RSUs?
What are the advantages and disadvantages of stock options?
What is a "sell-to-cover" approach with RSUs?
What are the tax implications of RSUs vs stock options?
How do RSUs affect cash flow?
How do stock options affect cash flow?
Can my RSUs go to my beneficiaries?
Can my stock options go to my beneficiaries?
What is an 83(b) election?
Are stock options or RSUs more predictable for my compensation?
Are stock options or RSUs easier to manage?
Are stock options or RSUs more risky?