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Money Girl

317 MG What Are Employee Stock Options and RSUs?

Types of stock benefits employees may receive and how they're taxed.

Broadcast on:
12 Jun 2013
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other

Types of stock benefits employees may receive and how they're taxed.

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I'm Laura Adams, the author of Money Girl Smart Moves to Grow Rich, a fun and practical guide to personal finance. Order the paperback or ebook from your favorite bookseller. You've probably heard about top employees at big companies who get paid stock options. No matter if you're already one of them, or aspire to be one someday, you should know how these benefits work. In this episode, we'll cover two types of employee stock options you might receive in addition to salary and other benefits. You'll find out how stock benefits help you grow rich, plus the huge difference in how they're taxed. An Employee Stock Option, or ESO, is a benefit given to certain employees of a company. Stock options give you the right to buy shares of the company's stock at a predetermined price. It's called an option because you're never obligated to buy in. It's always your choice. You might wonder why an employer would want to pay you with stock options instead of simply increasing your salary or giving you a cash bonus. Well, shareholders always want the value of their stock to rise. So tying some or all of your compensation to the company's stock price gives you an incentive to do an outstanding job, increase profits, and help the stock appreciate. This aligns shareholder and employee goals and makes everyone happy in theory. Here's an example of how a typical stock option benefit might work. Let's say Cindy starts a new job with Acme Inc. and is given 10,000 stock options as part of her compensation package. She has to wait a set amount of time, known as a "vesting period", before she can exercise part or all of the option. A typical vesting schedule might require her to wait a total of three years. For instance, Cindy might have the right to buy 2,000 shares after one year of service, 4,000 shares after working for two years, and the remaining 4,000 shares after being with the company for three years. I mentioned that options come with a predetermined price. So let's do the math if Cindy's option price is $10 a share. After one year on the job, Cindy can exercise her right to buy as many as 2,000 shares at $10 each, for a total purchase price of $20,000. Cindy's been watching Acme's stock price creep up to $15 a share, so she decides to buy shares at $10 each. Then she turns around and sells those shares for a profit of $5 each. That could potentially give Cindy a total gain of $10,000, which is 2,000 shares times a $5 profit, not bad. But the downside of stock options is that Acme's stock price could take a dive down to $8 a share and never climb above Cindy's option price of $10. In that case, she'd never exercise her option because there'd be nothing to gain from buying stock at a price above its trading value. You make money by buying low and selling high. That means Cindy would miss the opportunity to receive a bonus, even if she's been working hard. Tax on stock options can be a little tricky. You aren't taxed for simply exercising your option to buy stock. However, if you decide to sell it, you'll owe capital gains tax on your profit. You'll also owe tax if you receive any stock dividends. AI might be the most important new computer technology ever. It's storming every industry, and literally billions of dollars are being invested, so buckle up. The problem is that AI needs lots of speed and processing power. So how do you compete without costs spiraling out of control? It's time to upgrade to the next generation of the cloud, Oracle Cloud Infrastructure, or OCI. OCI is a single platform for your infrastructure, database, application development, and AI needs. OCI has 4 to 8 times the bandwidth of other clouds, offers one consistent price instead of variable regional pricing, and of course, nobody does data better than Oracle. So now you can train your AI models at twice to speed in less than half the cost of other clouds. If you want to do more and spend less like Uber, 8x8, and Databricks Mosaic, take a free test drive of OCI at oracle.com/advanced. That's oracle.com/advanced, oracle.com/advanced. Another type of employee stock benefit that you might receive is called Restricted Stock Units, or RSU's. Their purpose is similar to stock options to encourage top performance and retain great employees. However, Restricted Stock is very different from stock options because you actually receive company stock. Remember that a stock option only gives you the right to buy a stock at a specific price. With a grant of RSU's, you typically receive a certain number of stock shares over a vesting schedule. The value of this benefit depends on the price of the company stock at the time your shares vest. Let's say Acme is really pleased with Cindy's work and wants to keep her on board for at least three more years. They might give her 600 RSU's that are distributed over a three-year vesting period. For instance, she would receive full ownership of 200 shares in one year, another 200 after the second year, and the remaining 200 after the third year. If the value of Acme stock is $10 in one year when her first 200 RSU's vest, that's a benefit of $2,000 for Cindy. If the stock appreciates to $11 and $12 in the following years, she could potentially receive shares worth a total of $2,200 and then $2,400. Since restricted stock units are considered income, they're taxed in the year you receive them. Typically, a portion of your shares are withheld by your company to pay taxes, similar to how taxes are withheld from your wages. You receive the remaining shares as a net benefit and can sell them anytime you like. Having employee stock benefits is a great incentive to increase your company's stock price and bottom line by increasing revenue, cutting expenses, or doing both. If your company issues stock and you don't have stock benefits, talk to management about how you can become eligible. It may be possible if you create a plan to achieve aggressive company goals in your current position or gain the skills you need to land a future promotion. To read a transcript of this show or sign up for my free newsletter for tips you won't find in the podcast, just visit the MoneyGirl section at quickanddirtytips.com. This is episode number 317, called What are Employee Stock Options and RSU's. Also, be sure to connect with me on Facebook, Twitter, or Google+, my username on Twitter is @LaraAdams, L-A-U-R-A-A-D-A-M-S, on Facebook just to a search for MoneyGirl. I love getting your money questions through social media or email at money@quickanddirtytips.com. I'm glad you're listening to Ching. That's all for now. Courtesy of MoneyGirl, your guide to our richer life. [MUSIC] (dramatic music) [BLANK_AUDIO]