A Restricted Stock Unit, or RSU, is a form of stock-based compensation often given to employees at larger scale technology companies. The RSUs will eventually vest and unlike other stock options, have immediate value. Many employees discount their RSUs due to the level of complexity and jargon flooding the industry, and I would like to change that.
I am passionate about helping employees understand the full scope of their compensation package, and for tech employees, RSUs often play a significant role in that. Let’s dive into the world of RSUs and see how they can impact your financial landscape.
What are RSUs?
Unlike other forms of stock, RSUs are a promise of stock and aren’t delivered to the employee until the vesting schedule is complete. RSUs are based on the worth of the company’s stock and don’t have any value until they vest, meaning that they are an unfunded promise of payment until they become live.
This means that if you were to receive an offer that included 1,000 RSUs with 500 vesting in the first year and the remaining 500 vesting in the second year, you wouldn’t actually receive any stock until the end of that first year, or the completion of the first vesting schedule.
When stock options vest, they become “live” and available to buy and sell. RSUs are often considered “full-value” stock as they are worth the full value of the shares at the time of vesting. Returning to our example from above, if the first 500 RSUs vest and the company stock is worth $20 a share, the value of the shares comes to $10,000. Differing from other stock options, RSUs will always be of value to the employee when they vest and have a slim chance of going underwater unless the company stock is at $0.
How are RSUs used and taxed?
Now that you have an understanding of RSUs and how they work, it is time to see how you can put them to good use. Generally, employees have three options when their RSUs vest:
- Sell all of the shares
- Retain all of the shares
- Sell part and keep part of the shares
Selecting the right option for you often comes down to the tax consequences of each action. Many people think that they have to hold onto all of their shares for at least one year in order to receive the benefit of long-term capital gains tax. But that isn’t always the case.
RSUs are taxed the day that they vest, or become liquid. No matter what you decide to do with them, they will be taxed at ordinary income rates which takes into account federal, state, and payroll taxes. In most cases, your employer will withhold some of your RSUs in order to pay for the taxes owed when they vest. But some will allow you to pay your taxes in cash in order to hold onto all of your RSUs. Be sure to check with your employer about the specific withholding plan for your RSUs.
If you decide to sell your shares upon vesting, you won’t need to worry about paying capital gains tax, as the RSUs have already been taxed. You can then use the proceeds to put toward your other financial goals including re-investing them in a diversified account.
By holding onto your RSUs after they vest, you are essentially making the decision to buy stock in your company at the current price. If you hold onto them for a year and the stock decreases in value, you will incur a long-term capital loss even though that original amount was already subject to income tax. This is just something to keep in mind as you decide what percent of stock you want to retain and what percent you want to sell. Diversification is important in any investment portfolio which is why you should limit the amount of company stock in your portfolio.
Employees and RSUs
RSUs can be a great asset for many employees, but it is important to understand the caveats of this form of compensation to prepare your financial portfolio.
While RSUs can be a beneficial tool for employers and employees alike, it is important to remember that since the employee doesn’t actually own stock in the company until the RSUs vest, they don’t have any voting rights like a traditional investor, nor will they receive dividends paid while they hold the RSUs.
Employees should also know what happens to their RSUs should they leave their position either from a layoff or moving to a different company. Oftentimes, the language says that the employee will forfeit their RSU, which is just something to consider when you are looking at the vesting schedule. If, for example, your RSUs won’t vest for 3 years, you will need to think about your long-term goals working with the company to see if the offer is worth it.
As you are taking a look at the plan for your RSUs be sure you understand the following:
- The vesting schedule
- The plan in the case of termination, retirement, moving companies, death, etc.
- The plan if there is a merger or acquisition
- Taxes and withholdings
RSUs can be a wonderful addition to your employee compensation package. This promise of stock can offer many benefits but also has its drawbacks and consequences. Understanding the full scope of your RSUs and how you will use them to improve your long-term financial plan will help you on the path to reaching your financial and personal goals.
Do you want to talk more in-depth about your RSUs? Schedule a call with us and we would be happy to help.