Restricted Stock Units Vs Stock Options

If you have ever worked for a company that offers stock-based compensation, you might have come across terms like restricted stock units and stock options. These are two common ways companies reward their employees by giving them ownership in the business. But what exactly do they mean? How do they work? And most importantly, which one is better for Indian investors?

In this article, we will break it all down in a simple and easy-to-understand way. Let’s get started.

What Are Restricted Stock Units?

Restricted stock units are shares of a company that are granted to employees but with certain conditions. The most common condition is a vesting period, which means you do not get the shares immediately. Instead, you receive them over time as long as you continue working for the company.

How Do Restricted Stock Units Work

1. Grant: Your employer promises to give you a certain number of restricted stock units.
2. Vesting: You earn these restricted stock units over time, usually over a period of three to five years.
3. Settlement: Once the restricted stock units are vested, they are converted into actual shares that you can sell.

For example, let’s say a company grants you 1,000 restricted stock units with a four-year vesting period. Every year, 250 shares vest, and once they vest, you own them and can sell them.

Pros of Restricted Stock Units

• Guaranteed value as they always have some worth as long as the company’s share price is above zero.
• Less risk since you do not have to buy them; they are given to you.
• Simple to understand since once they vest, they are yours.

Cons of Restricted Stock Units

• Tax implications since they are taxed as soon as they vest, even if you do not sell them.
• No control over the purchase price since you receive the shares at the market price.

What Are Stock Options?

Stock options give employees the right but not the obligation to buy company shares at a fixed price, known as the exercise price or strike price. If the company’s stock price rises above this fixed price, employees can make a profit.

How Do Stock Options Work

1. Grant: The company gives you the option to buy a certain number of shares at a fixed price.
2. Vesting: Just like restricted stock units, stock options also vest over time.
3. Exercise: You choose whether to buy the shares at the fixed price.
4. Sell: If the stock price is higher than the fixed price, you can sell at a profit.

For example, if you get 1,000 stock options at a strike price of ₹200 per share, and after three years the stock price is ₹500, you can buy at ₹200 and sell at ₹500, making a ₹300 profit per share.

Pros of Stock Options

• Huge potential profits if the stock price rises significantly.
• Control over timing as you decide when to exercise and sell.
• No immediate tax burden since you only pay tax when you exercise the options.

Cons of Stock Options

• Can become worthless if the stock price is lower than your exercise price.
• Upfront investment required since you need money to buy the shares.
• Complex tax treatment as Indian tax laws on stock options can be tricky.

Key Differences Between Restricted Stock Units and Stock Options

Points to Remember When Choosing Them

Both restricted stock units and stock options have their advantages and disadvantages. The right choice depends on your risk appetite, investment strategy, and the company’s future potential.

If you want guaranteed value and less risk, restricted stock units are better. You get actual shares without having to buy them, and they always have value.

If you are willing to take a risk for higher rewards, stock options are better. If your company’s stock price grows significantly, you can make a lot of money.

However, taxation plays a big role in decision-making, especially for Indian investors.

Taxation of Restricted Stock Units and Stock Options in India

The Indian tax system treats restricted stock units and stock options differently.

Tax on Restricted Stock Units

• Restricted stock units are taxed as salary income when they vest.
• You pay tax based on your income tax slab rate, and if you sell the shares later, capital gains tax applies.

Tax on Stock Options

• When you exercise stock options, the difference between the market price and the exercise price is taxed as salary income.
• When you sell the shares, capital gains tax applies.

Since restricted stock units are taxed immediately on vesting, you might end up paying tax even if you do not sell the shares. On the other hand, stock options give you more flexibility in timing your tax liability.

Final Verdict

If your company offers both restricted stock units and stock options, here is a simple way to decide. If you prefer stability and a guaranteed payout, choose restricted stock units.

If you believe in your company’s future growth and can handle risk, choose stock options. Many companies, especially startups, prefer giving stock options because they require employees to take on some risk. On the other hand, large companies often give restricted stock units as a way to reward employees with less risk.

A Smart Strategy for Indian Investors

If you receive restricted stock units or stock options, here are some smart strategies to maximise your gains.

For restricted stock units:

• Be prepared for taxation when they vest.
• If you do not need the money immediately, hold them for long-term capital gains benefits.
• Diversify and do not keep all your wealth in company stock.

For stock options:

• Only exercise when the stock price is significantly higher than your strike price.
• Consider the tax impact before exercising.
• If your company is doing well, hold for long-term gains.

Conclusion

Restricted stock units and stock options are both valuable forms of stock-based compensation, but they serve different purposes. Restricted stock units are a safer option with guaranteed value, while stock options offer higher risk and reward potential.

For Indian investors, taxation is a key factor to consider. Restricted stock units are taxed upon vesting, while stock options are taxed when exercised and sold. Choosing the right option depends on your risk tolerance and financial goals.

So, next time your employer offers you stock-based compensation, you will know exactly what to do.

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