Should I take stock options or RSUs?
This year is special, as P&G has decided to move its next Long-Term Incentive Program (LTIP) award grant up from February to October. That means this one time, you may enjoy two LTIP awards in a calendar year: the 2019 award that happened in February, and the 2020 award happening this October.
It also means you must again choose how you will take your award: as stock options or as RSUs. We’re here to help with that decision.
What are stock options and RSUs?
Stock options are the voluntary option to buy shares in the future. P&G temporarily loans you the grant value, you get any gains from share price growth, and when you exercise the option, you give the original grant value back to P&G and keep the gains.
P&G options vest after three years and expire after ten, giving you a seven-year window to hope for strong growth you can leverage. The flip side is that if the stock price falls to be equal or less than the price of the original grant by the time you want to exercise, your options could end up worthless.
Restricted stock units (RSUs) are actual shares granted to you, available to you after the three-year vesting period. Unlike stock options, their value is their full market price when they vest, meaning that unless something catastrophic happens to P&G, they will always be worth something. RSUs also accumulate dividends, unlike stock options.
How to decide
There are two main variables to consider when making your LTIP choice: tax planning and the future growth of P&G stock.
1. Consider the tax implications of when you might cash in your award.
- Will you be retiring in less than 10 years? Consider taking at least part of your award as stock options. Their ten-year timeframe lets you defer income later to when you may be in a lower tax bracket. They’re taxed at your marginal rate when you exercise.
- RSUs are a more reliable source of income, available to you as either cash or shares on the vesting date, making them excellent for people planning ahead for big expenses like college. They’re taxed at your marginal rate when they vest.
- Proceeds from either one will allow you to contribute directly to your Roth IRA (if eligible) even after you stop working, because the proceeds are considered deferred earned income.
2. Weigh the potential future growth of P&G’s stock itself. Will P&G’s price keep rising over the next 3-10 years?
- If it keeps rising, then stock options will capitalize on this potential.
- If growth is slow or rocky, or a correction occurs, then RSUs are the safer choice.
- Because future growth is impossible to accurately predict, we recommend hedging your LTIP: Always take at least 25% of your bonus as RSUs.
Splitting your benefit between RSUs and stock options doesn’t make you pessimistic about your company’s growth. It makes you a savvy financial planner for your family.
Two scenarios for P&G price growth
Let's see how the two types of award play out in different scenarios. This graph shows the potential value of a $5,000 LTIP award this October that assumes steady 5% stock price growth and a 3% dividend. With these assumptions, the value of the stock options overtakes the RSUs by the third year and ends up nearly triple the value by the 10-year expiration date.
However, steady growth is not guaranteed at all. What happens to the comparison when there’s a major price correction? Let’s see how the stock options fare if, on the day after your LTIP grant, the stock price suffers a 20% correction:
The stock options are worthless for the first five years. The value eventually exceeds the RSU value after about eight years.
This is a problem because you may be counting on that income, only to have it be worthless when you need it. Or what if you successfully wait it out until year 8, but another correction happens with little time to catch-up before your options expire? These are the inherent risks that come with the higher potential reward of stock options.
This is why we advise clients to always take at least 25% of the LTIP award as RSUs. The remaining 75% is a personal decision based on all the other factors at play, but knowing at least 25% of your award will one day end up as a deposit in your bank account is a priceless ameliorant should you ever live through a longer term major stock market correction, or a long P&G stock specific correction.
Do you have more questions about your P&G or other corporate benefits and incentives? Our advisors have more than 50 years of combined Procter & Gamble experience. Call 513-469-8400 or click here to email one of our experienced advisors.