RSU’s or restricted stock units are a form of equity compensation often awarded to employees in the technology industry. They’re used as additional compensation in addition to a base salary in the form of stock ownership in the company. RSU’s can be an extremely valuable form of compensation and offer several planning opportunities. However, if you’re not familiar with how they work, or what these opportunities are, you’re most likely left asking, what to do with my RSUs? This article will explore the basics of RSU’s, tax consequences, and ways to maximize their benefits!
What is an RSU?
A restricted stock unit (RSU), is additional compensation given to employees in the form of company stock. Rather than your full compensation being in the form of cash, they’ll pay a base salary plus stock in the company. They’ve become synonymous with many of the technology companies looking to lure the best talent due to employees being able to reap the rewards often associated tech company growth. RSU’s can be an extremely valuable form of compensation and provide a “boost” towards achieving other financial goals.
Grant Date vs Vesting Date
RSU’s have two dates that recipients should be aware of. The first is the grant date. The grant date is the date shares of the company are pledged to you. It’s not until the granted shares of company stock “vest” will you actually own the shares. The next date is the vesting date. Once shares are vested, they’re fully owned by the employee and they may do as they wish with the stock.
Each company has a vesting schedule, which is commonly based on length of employment, or performance goals. The stock could potentially all vest at once, or a percentage could vest over a period of years. The date that the shares vest is the “basis” used for computing tax consequences. It’s treated just as if you had bought stock on that date in terms of computing tax when the stock is eventually sold. However, Uncle Sam must get his portion of this compensation, and on the vesting date, the market value of the shares is included as part of your income.
Let’s use an example to illustrate the tax implications of vested RSU’s. On July 1st, 100 shares of XYZ company stock vests. On this date, each share is worth $50. The total market value of these shares is $5000 (100 shares x $50 = $5000). The $5000 must be included as ordinary income on the recipients form W-2. Meaning the compensation is subject to withholding taxes such as social security, Medicare, and state and local taxes in addition to federal income taxes.
Your employer may or may not give you all or a few of the following options to pay withholding tax on the vested shares.
- Cash transfer: Use cash to pay the withholding tax. No shares are sold.
- Sell to Cover or Net Issuance: Both involve selling vested shares of stock to cover the cost of the withholding tax. Remaining shares are given to the recipient.
- Same day sale: Sells all vested shares and uses part of cash proceeds to cover withholding tax. Remaining cash is given to the recipient.
While nothing can be done to avoid this inevitable tax on the RSU’s, the good news is the shares are now 100% yours. The last tax consideration to be aware of now that you own the stock is what happens when you sell it. If the stock is sold prior to one year after vesting, the gain (increase in value since vesting) will be taxed at ordinary income tax rates (your income tax bracket). If held for longer than one year, the gain will be taxed at the more favorable long-term capital gains rates (0, 15, or 20% depending on your income tax bracket).
What to do with my RSU’s?
Now that we’ve covered the basics in regards to RSU’s we can dive into the planning opportunities around them. The most common question RSU recipients have is, should I hold, sell, or diversify my stock? In an attempt to answer this question, please keep in mind every person’s situation is different and several factors must be considered.
You may consider holding your vested shares of company stock if you believe the company is on a growth trajectory. The first company that comes to mind is Amazon, and it’s massive growth over the past 20 years. Employees who decided to sit on their stock in the early years have more than likely become very wealthy. However, with any concentrated position, there comes risk. Having “all your egg’s in one basket” inherently increases the risk your taking with your investments. While it may seem an investment is less risky because you know the company and you work there, it doesn’t change the simple fact that concentrated positions involve more risk than a diversified portfolio. If RSU’s are continually being granted, you may consider selling a portion of the stock and diversifying elsewhere, knowing that you’ll be receiving more company stock in the future.
Recapping on the tax implications, if you decide to hold company stock, remember GAINS are taxed at better rates if the stock is held for longer than a year. For example, if you have stock you’ve held for 9 months that’s appreciated in value by 15%, that 15% gain will be taxed at your ordinary income bracket if sold. Whereas if you waited an additional 3 months to sell the stock, the 15% gain would be taxed at the lower long-term capital gains bracket, potentially saving a lot of money in taxes.
Secondly, you may decide to sell the vested company stock immediately, or shortly thereafter. This could be a consideration for the mere fact of diversifying or potentially use the proceeds towards other financial goals such as a home downpayment, paying off high interest debt, building an emergency fund, or saving for kids college expenses.
RSU’s are a great benefit to have and understanding how they fit into your holistic financial situation is key to maximizing them. The key things to remember are the income tax consequences, and the potential to build up a fairly risky portfolio if the stock makes up the majority of your portfolio or net worth. While there’s nothing wrong with concentrated positions in company stock, it’s important to be aware of the risk and the potential pitfalls it could pose to your overall financial situation should the stock experience a dramatic downturn.
If you’d like to discuss your RSU’s and how they fit into your overall financial situation please schedule a free consultation with us today!
Levi Sanchez is a CERTIFIED FINANCIAL PLANNER™, BEHAVIORAL FINANCIAL ADVISOR™ and Founder of Millennial Wealth, a fee-only financial planning firm for young professionals and tech industry employees. Levi’s been quoted in the New York Times, Business Insider, Forbes, and is a frequent contributor to Investopedia. He is an avid sports fan, personal finance and investing geek, and enjoys a great TV show or movie. His mission is to help educate his generation about better money habits and provide financial planning services to those who want to start planning for their future today!