Equity compensation can be as valuable, if not more so, as cash compensation over the long-term. The election of Restricted Stock Units (RSUs), stock options, or a mix between the two is offered to qualifying employees every August. Let’s review some key factors that separate these two deferred compensation methods.
- Restricted Stock Units (RSUs)
Restricted Stock Units, or RSUs, are a less complicated and less risky form of deferred compensation than stock options. You’re granted a set “lot” of restricted stock units, a portion of which will vest every September, and the NKE shares will automatically be deposited into your Fidelity account. You may choose to keep the NKE stock or sell the shares. RSUs will always have net value unless the company stock is $0 at the time of vesting.
The total market value of the vested RSUs is taxed as ordinary income when you receive the shares. At delivery, Fidelity will withhold the estimated tax by immediately liquidating that value in shares. If you subsequently hold the remaining stock for one year and one day, the additional gain (if any) will be taxed at long-term capital gains (usually 15% or 20%). If you sell the stock before that, any additional gain is taxed as ordinary income.
Non-Qualified Stock Options, or NSOs, are awards that return a cash value if the market price of NKE is greater than the grant price at any time prior to or at expiration. While your Fidelity statements will not show a value for any “out-of-the-money” vested lots, the lots do have theoretical value. This value is primarily a function of the time to expiration and the distance between the grant price and the market price. All things equal, the longer the time to expiration and the closer the NSO is to being “in-the-money,” the greater the theoretical value.
Stock options are generally considered riskier elections because they require significant increases in NKE stock price to be worth more than RSUs. Said differently, if NKE stock trades at the same price near expiration as it did on the grant date, the NSOs will approach zero theoretical value.
The difference between the market value and grant price will be taxed as ordinary income upon exercise. At exercise, there is a simultaneous purchase and sale of NKE stock resulting in the creation of a cash value, net of estimated tax, in your Fidelity account.
What do I elect?
The previous discussion brought forth an obvious differential: time duration. RSUs are a form of short-term compensation while NSOs are a form of long-term compensation. This means that expected duration of employment is a critical factor in your election.
Equity Compensation Priority Factors:
- Duration of future employment
- Return outlook for NKE shares
The shorter the duration of expected employment the more the outlook on NKE shares becomes irrelevant. Even an extremely positive outlook on NKE is unlikely to result in NSOs being worth more than RSUs if employment is only one year in length. But the longer the duration of employment the more relevant that positive outlook becomes.
If you plan to stay for less than three years, it is generally advisable to elect 100% RSUs. If you plan to work for six years or more, it is generally advisable to elect 100% NSOs. There are instances in which the outlook for NKE shares will change these two time periods from 100% to 50/50 elections. Vision Capital maintains an outlook and will advise specifically should this scenario occur. Otherwise, expected employment of between three and six years typically calls for a 50/50 election. However, the outlook for NKE is more critical in this three-to-six-year time frame, particularly the closer to either three or six years. Done appropriately, your equity compensation will be more of a wealth accessory and less of a hopeful gamble.
As we near the election period, it’s important to check in with your trusted CERTIFIED FINANCIAL PLANNER™ Professional and notify us if at any point you believe your employment plans may change. We also recommend checking in with your CPA since stock compensation comes with increased tax liability. Your advisor can help you to determine the best strategy for your individual circumstances, which may change year-to-year.