A Guide To Restricted Stock Units
Offering restricted stock units (RSUs) is a common way for employers to extend stock-based compensation to their employees. More employees are starting to see RSUs as part of their overall compensation arrangement. Receiving RSUs or stock-linked compensation is a sign that things are going well in your career! Since they are an important part of your compensation and becoming a significant part of your net worth, it is worth having a deeper look at the impact RSUs will have on your financial plan. Here is what you need to know.
What is an RSU (Restricted Stock Unit)?
Restricted stock units are a stock compensation vehicle that many publicly traded companies use to pay a portion of your total compensation. An RSU is a grant valued in terms of company stock, although its stock is not issued at the grant date. When the RSUs vest, your company will distribute shares (sometimes cash) equal to the units’ value.
What details do you need to know about Restricted Stock Units
There are some key facts you will need to know about your RSUs. The most crucial fact is the vesting date. The vesting date is when your restricted stock units turn into shares you receive and own and is also when you will be taxed. You should also know how many RSU shares you have. Your vesting schedule is important to understand. Most companies use a schedule where your shares will vest over a certain period. A sample vesting schedule that we commonly see could be a 4-year schedule, receiving 25% each year. Some companies have performance metrics they use to determine how many units you will receive each year. Having this information will be critical to creating a strategy on how to handle your RSUs.
Tax Rules for Restricted Stock Units
Many people get confused about how RSUs are taxed. Your restricted stock units are initially taxed as ordinary income and will show up as income on your paycheck stub. Taxes are based on the price of your company’s shares on the vesting date. Don’t confuse the grant date and vest date. It would help if you also had an understanding of how your company handles withholding tax. Usually, companies will automatically tender your shares to cover tax withholding a specified percentage. Tendering some of your shares means you will give some of your shares back to the company, and they will sell them on your behalf to use them to pay some of the taxes due. If you are unsure how taxes are handled, you will want to get more information on this to prevent an unwelcome surprise when you file your taxes.
If you plan on holding onto your shares after your RSU vests, you will have to focus on the second type of tax when you sell your shares; capital gains or losses. You will always owe ordinary income taxes on the amount of RSUs that vest on the vesting date, but if you hold the shares longer (not an immediate sale), you will owe taxes when you sell the shares at some point in the future. The holding period starts on your vesting date, so if you sell your shares before one year, the gains made on your stock will be subject to short-term capital gains tax rates. If you wait to sell your shares at least 12 months after your shares vest, then you will be subject to long-term capital gains tax rates, which can be a lower rate than your ordinary income tax rate.
Taxes are an important component when planning for RSUs. Some people think that when their RSUs vest, they only have to pay capital gains. That is incorrect and can be a costly error when tax season rolls around.
How Do Restricted Stock Units Factor Into Your Financial Plan
Your RSUs are part of your net worth and need to be factored in your financial goals and plan. Even before your units vest, it is essential to craft a strategy. My experience with RSU holders is they do three things with their units. Sell them at the vesting date, let them ride, or some combination of the two. Each of these approaches could be appropriate for you based on your financial situation.
If you are inclined to sell all your vested units, you should know your company’s policy on withholding taxes. Next, knowing what you plan to do with this windfall is extremely important. If you follow this strategy, you can quickly start to think of your vested RSUs in the same way you would receive a cash bonus from your company. We see clients use the proceeds to boost their emergency savings account, top off a 529 college savings account, start a pre planned home improvement project, pay down debt, or invest for future opportunities. It should not be used as newfound money and squandered.
Holding onto your shares is also an option. If you are confident that there is upside appreciation potential for your company’s stock and are comfortable financially, this could be an option. The more critical part of the prior sentence is that you are financially comfortable. Just because you’re optimistic about your company’s future doesn’t mean you should hold onto your stock if you could put that money to better use today. The opportunity to diversify your holdings or contribute to other financial areas should supersede any hope of the stock appreciating unless your financial plan is in great shape.
In my experience, you likely will continue to receive RSUs as part of your compensation package. Your company will continue to issue you more restricted stock units, and you will have more units vest each year. Having a regular flow of RSUs will also increase your need for a solid financial plan. While it’s impossible to know the exact value of your shares in the future, building this information into your long-term financial plan can provide confidence that you’ve weighed your options and have a well-thought-out strategy in place. Too many times, these (sometimes considerable) chunks of wealth are treated as an afterthought.
Restricted stock units and other stock-based compensation will be more common as you progress through your career. It is important to know a few key details and how they fit into your financial planning strategy.
Brandy Branstetter, CFP®
Principal Wealth Advisor