Should I take stock options or RSUs?
2021 marks the second year P&G has awarded its Long-Term Incentive Program (LTIP) grants in October. This means every late summer, Procter & Gamble employees eligible for LTIP awards must select how to split this grant: as stock options or as Restricted Stock Units (RSUs). We're here to help with that decision.
What are stock options vs. 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.
a. For example, 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.
b. 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.
c. 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?
a. If it keeps rising, then stock options will capitalize on this potential.
b. If growth is slow or rocky, or a correction occurs, then RSUs are the safer choice.
c. 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.
Next: We run the numbers for two scenarios of stock price fluctuation.
Two scenarios for P&G price growth
This graph shows the potential value of a $5,000 LTIP award this October that assumes steady 5% stock growth and a 3% dividend:
With steady price growth, the value of the stock options overtakes the Restricted Stock Units 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? P&G veterans know it’s happened before.
Let’s see how the stock options fare if, on the day after your LTIP grant, P&G stock suffers a 20% correction:
The value of the stock options are worthless for the first five years, but 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? These are the inherent risks that come with the higher potential reward of stock options, and the reason 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.