Are RSUs a mystery to you? Restricted Stock Units are a popular perk for employees and give you an ownership stake in the company you work for. But how do RSUs work? Let’s go over a few things about this form of equity compensation.
RSUs by themselves are not stock. If your company gives you 100 RSUs, those units are your company’s promise to give you 100 shares of company stock at a future date. You might not get all of those shares at once, though; you’ll have to wait for them to vest.
When you are given your RSUs, you’ll get a schedule showing you the vesting periods and how many shares apply to each. It could be gradual, such as 25% of shares vesting each year for 4 years, or cliff vesting, where the shares all vest at the same time after a certain number of years.
RSUs function as an incentive by your employer for you to stay with the company and help it succeed. If you leave the company before your RSUs vest, you lose them. When your RSUs vest, they convert into real shares of stock, and you become an owner of your company.
Taxes and More Taxes
Keep track of your vesting schedule! The value of the stock that you receive is considered compensation to you in the year that it vests, and you’ll owe income taxes and payroll taxes on it. These taxes are withheld from your salary and the income is reported on your W-2. You may have to pay quarterly estimated taxes on the income if not enough is withheld. Employers sometimes give stock recipients the option to sell some shares at vesting to cover the taxes.
If your stock increases in value, there will be another tax bite when you sell it. Capital gains taxes will be imposed on the growth in value since vesting. If you hold the stock for longer than one year, you’ll pay those taxes at the more favorable long-term capital gains rate.
For more information on reporting RSUs on your tax return, see Investopedia.
The Difference Between RSUs and Performance Stock Units (PSUs)
Unlike traditional RSUs, Performance-Based Grants include business goals set for your company. Employees are granted a target number of performance units, and this grant is adjusted up or down based on the company’s success. If your company meets certain financial goals within a predetermined time frame, you will receive the target number of shares. If your company exceeds those goals by a specified amount, you will receive more shares. If your company does not meet the target, you will receive fewer shares, or none at all. Until the vesting period ends and the company’s performance is evaluated and certified, you will not know how many shares will vest.
The Hawley Personal Finance Approach to RSUs
I usually recommend that clients sell RSUs (and PSUs) upon vesting. This allows you to lock in the current market value and it gives you the opportunity to use the funds for other investments or expenses. Remember, RSUs are taxed at vesting, just like a cash bonus. It is an “opt in vs. opt out” paradigm. Keeping RSUs when they vest ends up being the same as using a cash bonus to buy company stock. Holding RSUs for favorable long-term capital gains rates might seem appealing, but keep in mind that you are putting the entire position at stake for reduced taxation on the gain…if there is any!
To secure the value of your RSUs, it is generally best to sell them when they vest. Sometimes this isn’t possible right away, if you are subject to blackout restrictions. Blackout periods limit your ability to sell your RSUs, although you may be able to make elections to avoid these restrictions.
Another advantage to selling the shares rather than holding onto them is your ability to reduce risk through diversification. By spreading your investments among a variety of asset types, you can potentially stabilize the growth of your overall portfolio.
While it’s satisfying to feel like an owner of the company you work for, relying heavily on one company for both your salary and your net worth creates a vulnerability. If the company encounters financial difficulties, you could face the risk of losing both your job and the value of your investment.
The Bottom Line
- RSUs, a form of compensation, are an incentive from your employer that rewards your contributions to the company’s success.
- You have to wait for the RSUs to vest before you own the shares. Knowing your vesting schedule will help you plan for taxes.
- You’ll pay income taxes when the shares vest and capital gains taxes if the stock increases in value before you sell it.
- The value of your RSUs depends on your company’s stock performance.
- Performance Stock Units offer more potential rewards and carry greater risk than traditional Restricted Stock Units.
- Selling the stock once it vests is a way for you to diversify your portfolio and reduce risk.