As you advance in your career, there is a good chance that you will eventually come across employer incentives like equity compensation offers and other advanced savings strategies.
Employer benefits like equity compensation are an opportunity for employees to gain ownership in the company where they work. The employer benefits from employee retention while incentivizing company growth. Equity compensation is most commonly used within publicly traded organizations or organizations that plan on going public soon.
Compensation options offer flexibility but can bring complexity to your financial situation.
- What type of equity compensation do you have?
- What are the rules?
- How can you make the most of this crucial financial opportunity?
Read along with our three-part series designed to bring confidence, clarity, and excitement to this significant company benefit. Our goal is to help you turn your equity compensation from stress to success.
We’ll kick off this series with Restricted Stock Units (RSUs).
What are RSUs?
Restricted stock units are a type of equity compensation granted to employees via company stock. Unlike stock options where you have the right to purchase shares at a later date, you own the company shares as soon as the RSUs vest.
RSUs are accompanied by strict vesting and distribution schedules that are often based on your time with the company, performance (personal or company-wide), or a combination of the two. Company’s use this form of equity compensation as an incentive to attract and retain top talent. Find out about these programs before you start a new job, don’t wait until you’ve signed on the dotted line. Signing bonuses and other incentives can be part of your negotiation.
Key Terms:
- Grant Date: The day your company gives you the RSUs.
- Vesting Schedule: The timeline that determines when employees can take advantage of their RSUs. For example, you may have been “granted” 400 shares, but the shares “vest” at a rate of 100 shares per year for four years. In this case, it will take four years for all of your RSUs to vest. Keep in mind that you can’t do anything with your RSUs until they vest.
- Vesting Date: The specific date on which your RSUs become company stock and available for your use—hold or sell. Using the previous example of the 400 share grant, 100 shares may vest on June 30th of every year for four years. The vesting date also marks taxable event #1—more on that later.
It is reasonable to think about RSUs in the same way you think about an annual or quarterly bonus. You will receive company stock at predetermined intervals based on performance and/or time with the company.
Remember that RSUs do not require you to purchase the stock with your own funds (unlike some other types of equity compensation). The shares are granted (or given) to you as an incentive.
How Are RSUs Taxed?
Taxes? Yes, unfortunately, you do have to pay the proverbial “taxman.” As soon as your RSUs vest (on the vesting date), the value on that date is considered income. Then it’s taxed as such.
In addition to ordinary income tax (often 30% or more), you will also pay taxes when you sell your shares-taxable event #2. You’ll be taxed at long-term or short-term capital gains depending on how long you held the shares. Remember, it’s still compensation, you just have some additional options about when to pay your taxes.
An Example:
- On 6/30/21, 100 shares of your RSUs become fully vested. On that day, the value of the company in the public market was $25 per share.
- You will now owe taxes on $2,500 of additional income for that year (100 shares x $25 = $2,500).
- Let’s also assume that you do not sell those 100 shares until 10/30/22 (the following year), when the company is valued at $40 per share. Since you held the shares for over one year, you will owe long-term capital gains taxes on the $15 per share gain ($15 gain x 100 shares = $1,500). Had you sold the shares prior to holding them for one year, the $1,500 gain would have been taxed at ordinary income tax rates (aka short-term capital gains). Ouch!
Keep in mind that the strategy for holding and selling RSUs is hardly black and white. In some cases, it makes sense to sell your shares as soon as they vest for cash flow and diversification purposes.
We’ll let you in on a little secret: Google doesn’t have all the answers. Working with an advisor to simulate different scenarios can be a powerful decision-making tool.
Three Tips To Make The Most of Your RSUs
While RSUs may initially seem a bit confusing, they do possess quite a few known facts. This means that there’s a lot about RSUs that we can control and plan around.
So how can you make the most of your restricted stock units?
1. Remain At The Company and Do Your Part
When it comes to RSUs, perhaps the most fundamental method for success is remaining at the company while you increase stockholders(that’s you!) value. It’s helpful if you stay long enough for all your shares to vest. If you were granted 400 shares and only 200 have vested when you leave, you give up your right to the remaining 200 shares. That would be a 50% loss! Keep in mind that if you and your coworkers don’t do their part and help the business grow, your company may see a decline in value.
While your shares should not be the sole reason to stay with a company, they should factor into your decision-making process. If all of your shares vest within a year, sticking it out could be a solid financial move.
2. Withhold Enough Taxes
On the vesting date, your employer may withhold taxes automatically. In most cases, they will do so by selling some of the shares to cover the tax burden. You may have to ‘opt-in’ for this process. If you don’t, you could be in for an unpleasant surprise come April.
The problem is, the IRS only requires companies to withhold 22% for taxes. Depending on your unique tax situation, this could be way different than your actual tax liability. Double-check your withholding rate and err on the side of caution (i.e., withhold a bit more than you think you need to).
Don’t get caught off guard. If the share price has dropped significantly between vest date and sale date and you expected to use future proceeds to pay the bill, you could be in trouble.
Let’s look at how things can go wrong. Say you have 1,000 shares vesting at $100 per share and you have a 30% marginal tax rate. That leaves you with a $30,000 tax bill ($100,000 x 30%). What if you wait to sell and the price per share sinks to $60? In this scenario, you lost nearly half of your proceeds to pay your upcoming tax bill.
What if everything goes great and the stock price remains steady or appreciates? Holding onto your investments for a year or longer to take advantage of the lower long-term capital gains rates is definitely intriguing. Your tax rate could drop down to 15% as opposed to 30+%!
3. Diversify Your Investments
It is not unusual for employees to have too much invested in their company’s stock. Ask yourself, what percentage of your net worth do your vested RSUs account for? It is not generally advisable to have a large portion of your investments tied up in one company, especially the company you work for.
Many investors suffer from investing FOMO (fear of missing out). This emotion is especially true when factoring in the biases inherent in investing in your company.
A strategy we like to use with many of our clients is to have them sell their RSUs immediately on the vesting date. In this scenario, you would pay the upfront tax burden (via the sale of shares), and benefit from global diversification. Additionally, it actively eliminates excessive risk you carry when most of your investments are tied to your main source of income.
Think About RSUs as One Piece of Your Portfolio
At first glance, it’s easy to get lost in the timing (vesting) and logistics (taxes and diversification) of your RSUs. But it’s essential to create a strategic plan from the onset to avoid confusion, over-concentration, additional risk, and other tax liabilities later on. Ask yourself,
- What other investments do you have?
- Do your shares comprise over 10% of your net worth?
Putting all of your eggs in the RSU basket opens you up to significantly more risk. If your company continues to do well, you’ll do well.
But if the company loses steam or you pursue other employment opportunities, you could throw a big wrench into your financial situation. Let’s not forget companies like Enron, which dropped from over $90 a share to less than $0.25 cents, devastating employees and Wall Street professionals alike.
Selling a significant portion of your RSUs will likely be part of your plan, making it critical to take the emotion out of it—even if it is a company you believe in.
Your company doesn’t necessarily have to keep your personal best interests in mind—that’s not their job. They have a lot of skin in the game. They are financially incentivized to encourage their shareholders to hold (not sell) their stock.
It’s our job to help you use your money in ways that keep you moving forward. Your portfolio should balance risk and return, and we love helping clients strike the right balance for them.
Equity compensation can become rather complicated as you dig into the details. Having a financial professional with experience in dealing with RSUs and other types of stock options can be a real-time and money saver.
Book a call with our team today and learn how we can help you effectively manage your equity compensation.
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