RSU’s or restricted stock units are a form of equity compensation. They offer an incentive in the form of company stock to remain with a company. RSU’s can be a very valuable form of compensation and offer several planning opportunities. However, if you’re not familiar with exactly how they work, or what these opportunities are, you are most likely left asking, what to do with my RSUs?
Before we dive into any planning opportunities around RSU’s, it’s important to understand the basics.
What is an RSU?
A restricted stock unit (RSU), is stock given to an employee by a company as an incentive to stick around. Which means the company is giving ownership to employees. It can be a win-win for both the company and employees. Longer employment typically leads to more productivity, which leads to the company being more profitable, and the employee participating in those profits.
Grant Date vs Vesting Date
RSU’s have two main dates that recipients should be aware of. The first is the grant date. The grant date is when your company pledges shares of the company to you with the promise to give these shares to you at a further date (vesting date). Hence the “restricted” part. Shares are “restricted” subject to a vesting schedule and you can’t actually do anything with the shares until they’ve vested.
The vesting schedule 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 a 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 then $5000 (100 shares x $50 = $5000). The $5000 must be included as ordinary income on the recipients form W-2. Meaning that 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.
There isn’t a cookie cutter solution to choosing what to do with your RSU’s on the vesting date, however, we’ll cover a few of the different situations when we review planning opportunities at the end of this article.
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 you may think that an investment is less risky because you know the company and you work there, it doesn’t change the simple matter of fact that concentrated positions involve more risk than if you’re diversified. 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 to store up on cash for liquidity. Because nothing can be done about the income taxes paid on RSU’s, if you sell immediately the short-term capital gains will be very minimal if nothing at all, and the proceeds could be used for other financial goals like buying a home, funding a 529, or a Roth IRA.
RSU’s are a great bonus in compensation that employers can potentially give their employees. The key things to remember are the income tax consequences, and the potential to build up a fairly risky portfolio if the stock continues to accumulate. While there’s nothing wrong with concentrated positions in company stock, it is important to be aware of the risk.
If you’d like to discuss your RSU’s and how they fit into your overall financial picture 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!