5 Types of Stock Compensation: Unscrambling the Alphabet Soup

May 21, 2024

-

Anastasia K. Wiese

X Close

Anastasia K. Wiese

JD, CFP®

Senior Financial Advisor

anastasia@grandwealth.com
P:
616-451-4228

Many of our clients receive a large amount of their compensation in the form of stock options. It’s a simple concept—incentivize key leaders in a company to lead in ways that increases the company’s value—but there are a growing number of ways to do this, and acronyms you need to know: RSUs, PSUs, SARs, and more! Let’s take a few minutes to unscramble the alphabet soup so you know what you’re getting, and how to put these valuable types of compensation to work for you.

RSU - Restricted Stock Units

RSUs are great because they are awarded over a defined period of time. They are called “restricted” because they vest (become available to you to redeem at its full value) gradually over time. This is away for companies to reward executives for staying with a company.

For example, your company might offer you 1000 RSUs over 5 years that vest at 200 shares per year. Therefore, for each year of employment, you receive 200 shares of stock. If you were to leave the company after 3 years, you would be able to retain 600 shares but not the remaining 400 that have not vested yet.

What do you need to know about RSUs?

- You don’t need to pay for RSUs

- Typically, you won’t receive dividends, voting rights, or pay taxes until the stock vests

- When your stock does vest, its value is reportable as regular income on your tax return

PSU - Performance Stock Units

Usually offered to top performers, PSUs put you in the driver’s seat by making them conditional on meeting specific goals. When you meet the goals within the time frame set by your PSUs, you receive the stock. In some cases, your goals might include different tiers or a sliding scale that ties your performance to how much stock you receive.

For example, your company might offer you 1000 PSUs for raising the price of your company’s stock, making a key deliverable, or hitting a deadline. They may also include provisions that increase the award to 1500 when you exceed the goal, or award only 500 if you satisfy some, but not all, of your goal’s metrics.

What do you need to know about PSUs?

- You don’t pay up front for PSUs

- Typically, you won’t receive dividends, voting rights, or pay taxes until the stock vests

- When your stock does vest, its value is reportable as regular income on your tax return

SAR - Stock Appreciation Rights

SARs are similar to other stock options, except they don’t involve an initial issue of stock. Rather, they offer cash compensation based on the price appreciation of the company’s stock during a period of time. Typically, when SARs vest you will be able to exercise them and receive payment in cash or stock.

For example, your company might offer you 1000 SARs as a part of your compensation that vest after 1 year and have a current share price of $10.00. If the stock goes up to $25 per share, your SARs would be worth $15,000. Appreciated value of $25,000 - initial value of $10,000 =$15,000. You may have the option to wait longer and continue to increase the value of your SARs, depending on the terms and expiration date your company has set. Eventually, you’ll exercise your SARs and receive their value in cash or stock.

What do you need to know about SARs?

- You don’t pay up front for SARs

- Take note of when the exercise period allows you to receive your payment as SARs typically have an expiration date

- The value of your SARs isn’t taxed when they are issued or when they vest, only when you receive payment, and then is reportable as regular income

Phantom Stock

Phantom stock is another desirable award because they typically pay in cash. As the name suggests, it’s not real stock! Instead of actual stock, your employer will grant you a number of hypothetical shares of stock that are tied to the company’s stock price. Like PSUs and RSUs, phantom stock may come with a vesting schedule, and like SARs it can be based on appreciation only instead of the stock price.

For example, your company might offer you 1000 shares of phantom stock that vests after 2 years. Stay with the company for those 2 years, then the stock vests and you can exercise your phantom stock for a cash payout.

What do you need to know about phantom stock?

- Any company can create their own phantom stock program with their own rules

- Phantom stock may offer benefits like actual stock, such as dividends or voting rights

- Phantom stock is not taxed until you receive your cash payout at which time it is reportable as regular income

ESPP - Employee Stock Purchase Plan

ESPPs are a common and easy way companies allow you to build up your ownership stake. Typically, an ESPP would allow you to use after-tax payroll deductions to purchase company stock at a discount.

For example, your company might offer you a15% discount on shares purchased through your ESPP. You could then deduct $1000 of your after-tax income and receive $1150 worth of stock.

What do you need to know about ESPPs?

- The discount on your company’s stock is not taxed

- Many ESPPs require you to hold the stock for a certain amount of time before selling, typically 1 year

- Your shares are subject to capital gains tax when you sell them after the holding period; if you sell them before the holding period they are reportable as regular income

As you can see, executive stock options are complex and impact your tax position. If you are someone with stock options as a part of your compensation, I highly encourage you to reach out to a trusted financial advisor to help guide you to maximizing these benefits. We love helping our clients navigate these financial decisions and welcome a conversation with you about yours as well!

Disclosure:
Grand Wealth Management ("GWM") is an independent investment adviser registered under the Investment Advisers Act of 1940, as amended. Registration does not imply a certain level of skill or training. More information about GWM including our investment strategies, fees, and objectives can be found in our ADV Part 2, which is available upon request.