In recent years, as employers attempt to find additional methods of retaining valuable employees, Restricted stock units (RSUs) have become a more familiar component of an employees’ compensation package. Especially here in the Pacific Northwest, where mature corporations and large tech companies are found on every block, individuals can increasingly expect RSUs to play a massive part in compensation. But what exactly is an RSU? And more importantly, how can you navigate the complexities of RSUs to accomplish your personal and financial goals?
What are Restricted Stock Units?
Restricted stock units are an additional form of compensation by which employers provide employees shares of their company stock. Typically, RSUs are granted or promised to an employee on one date (grant date), and then later down the road those shares will vest (vest date) after the employee continues to work for the company for a certain period of time. While an employee is waiting for shares to vest, they will have no physical ownership of those positions and therefore no right to the underlying value.
What Happens When My Shares Vest?
Once shares have vested, those shares are delivered and are available to the employee in their provided brokerage account. Additionally, the underlying value of the shares on the vest date will be taxed to the employee as ordinary income. Most companies will withhold a certain portion of the shares (the default is typically 22%) to make sure the employee does not have a massive tax bill come April.
For instance, let’s say an employer grants an employee 200 shares of company stock on February 1st while the stock is trading at $90/share. These shares vest in three months. on May 1st. At that time, the stock has increased in value and is now trading at $100/share. This means that the employee is now entitled to $200,000 in the form of company stock. However, due to tax withholding, they can expect $156,000 of company stock to be delivered into their account or 156 shares (22% withheld for taxes). It is important to note that even had the company stock depreciated from the time of grant to vest, the employee will still receive the value of the shares upon the vest date (although a lower total dollar value).
When your shares have vested, you have complete control over those positions. This means that you can choose to sell the shares immediately and use the cash to either diversify your portfolio or supplement cash flow, or you can continue to hold those shares in company stock. Remember, if you choose to sell those positions right away you will have no additional tax burden as you have already paid ordinary income on those shares. However, if you continue to hold shares after they have vested and wish to sell at a later date, they will be subject to short-term or long-term capital gains rates depending on the holding period.
What Should I Do with my RSUs?
How you should handle your RSUs certainly depends on your particular financial situation. However, more often than not our recommendation for individuals is to sell these shares as soon as they vest. This is because tying your investment assets (stock) and your human capital, (the income you receive from your employer), to the same company is risky. While ownership in your company can create a sense of pride and fulfillment, remaining rational about your reliance to one company in relation to your overall financial picture may prove more pertinent to long-term success. Additionally, it is important to remember that diversifying out of your company stock does not necessarily mean you can longer participate in the growth of the company. If you remain with the company, you can usually expect your human capital to grow along with your employer and you more than likely have additional unvested RSUs coming down the road.
Looking at Restricted Stock Units Through a Different Lens:
One way to think about RSUs, that I believe is particularly effective, is to think about the additional compensation you are receiving as cash, rather than company shares. As noted above, the tax characteristics of RSUs are the same as cash compensation in the sense that as soon as the RSUs vest they are treated as ordinary income. So, if we were to continue with the above example and assume you receive an additional $156,000 net of cash, would you immediately turn around and invest all those dollars into your employer stock? For most individuals, the answer is definitely not. However, when you continue to hold these shares rather than diversify away from them, that is essentially the route you are taking.
Everyone’s situation is unique, therefore developing a strategy for managing your RSUs will depend on your individual financial goals and needs. If RSUs are included in your compensation package and you would like to discuss the best way to manage them, please schedule a time to talk with our team.