Restricted Stock Units (RSUs) are one way your company can grant equity as part of your compensation package. This type of grant allows you to receive shares of stock without paying for them (in contrast to options – which we will discuss in a future post).
In this post, we’ll give you the details you’ll need to know to understand how this type of equity can affect your financial plan. For an overview of equity compensation, refer back to our post Where to Start When You Have Stock Compensation.
The most common RSUs we deal with are for clients who work for public companies like Facebook, Disney, Microsoft, and Google. Companies give RSUs as part of their initial job offer, as part of an annual performance review process, and/or as part of a promotion to a new role.
If you’ve been granted RSUs, you’ll want to understand a few key details that are provided in the documents you’ll receive.
Grant Letter, Grant Notice, or Award Letter – this is the document that describes what you are receiving. It will include the number of shares, the grant date, and the vesting schedule. This information is specific to you and your award.
RSU award agreement – this is the document that gives more details about the plan in general such as what the award means, the tax withholding options, the rules surrounding dividends, and other provisions such as the transferability of RSUs.
Vesting requirements – it’s important to note that an RSU grant does not give you shares that you can sell right away. Often, there are requirements specified as to how the RSU becomes an actual share of stock (i.e. “vests”). Usually, there is a schedule by which you earn the right to keep the stock. Sometimes there are additional requirements like performance metrics or goals that you need to hit. Popular schedules are yearly and quarterly vesting. Not every grant from your employer may have the same vesting schedule, so pay attention to each one.
Substantial Risk of Forfeiture – you may see this language describing your RSUs or in tax rules. All this means is that you have not completed the requirements for vesting yet. For example, if you leave the company before RSUs are vested, you will not receive the stock.
Custodian – once your shares vest, they are held in an account in your name at a financial institution that your employer has chosen to administer the program. You’ll receive login information when you receive a grant of RSUs and you’ll need to log in and “accept” the grant. Popular custodians are Fidelity, ComputerShare and Morgan Stanley.
RSUs are one of the easier types of equity compensation to understand when it comes to taxes. When you receive a grant of RSUs, the company usually assigns a dollar value to that grant to show you what those shares would translate into on the date of the grant. There are no tax implications upon grant.
This dollar value of the grant is more for mental accounting for you, and it means nothing from a tax perspective. As a side note, it’s nice to keep note of the value of the grant in case you end up leaving your job before the shares vest. You may want to negotiate any new job offers to match that value in additional salary, sign-on bonus, or an RSU grant in the new company.
When your RSUs finally vest, the shares are valued as of the vesting date, and you’ll be taxed on that value. This value could be more or less than the value when granted. For example, if you received a grant of 100 shares of Microsoft stock last year at $250 per share, it was worth $25,000. On the day it vested, the stock was trading at $300 per share, so the value to you was actually $30,000. Depending on the price of the stock on any given day, your shares could be more or less than the value on the grant date.
Great, now you have $30,000 of Microsoft stock! But wait, you’ll have to pay taxes on that because it is income to you. It’s not like your company gave you $30,000 in cash though. Companies are required to withhold to cover any estimated federal and state taxes just like they do from your regular salary. This additional income and withholding will be noted on your paystub and included in your W-2.
You may be able to choose how to pay this withholding amount. The easiest way to do it is to allow your company to withhold shares of your newly acquired stock to pay it. Another way to do it is to pay cash yourself to cover the withholding. One important thing to consider is that withholding is an estimate of your tax liability. It’s possible that you will owe additional taxes when you file your return if they didn’t withhold enough. We’ve seen many new clients surprised by this come tax time.
What happens once you sell the shares you’ve received? The initial price upon vesting is your “basis” in the stock. As time goes on and the price of the stock fluctuates, your stock will either be worth more, or worth less, than this original basis. If you sell it when it’s worth more, you now have a capital gain that you must pay taxes on. If you sell it when it’s worth less, you have a capital loss that you may be able to deduct on your tax return.
It’s important to understand the difference between the “income” tax you pay upon vesting, and the “capital gain” tax you pay upon selling. They are two different things.
Planning for RSUs
As I mentioned above, the tax implications are one way we help clients plan for RSUs. It’s important to understand how much is being withheld by your employer, and if it’s enough to cover your tax liability. We can help by assessing your full tax situation which includes the RSUs, your income, your spouse’s income, and any other special tax circumstances you may have. Depending on when the RSUs vest, it may be possible to adjust your other withholding to compensate or even make estimated tax payments to avoid surprises during the spring tax filing season.
Beyond planning for tax impacts, you may need help understanding what this newfound investment means for your full financial picture. RSUs can have a significant impact on your ability to reach your financial goals.
When you’re early on in your career and you are just starting to accumulate wealth, a few thousand dollars’ worth of company stock may not mean much. It’s great to get it, but it’s not changing your life yet. In this case, we usually talk through your financial goals, your tax situation, and your appetite for risk in your investments.
As you advance in your career and you earn more RSUs, then it starts to get interesting.
We’ve seen clients who come to us with years of stock accumulated from their employer RSU grants. There are two challenges with this situation. Clients get emotionally attached to watching the value of the stock grow. There is a psychological bias toward holding the stock because it’s like a gift from your employer.
The other challenge is the economic and investment risk you are taking by working and investing in the same company. There could be situations where your job could be in jeopardy at the same time the company stock is sliding. You may lose employment at the same time your investment is becoming less valuable. On the other hand, if you are advancing in your company rapidly, you may be getting more and more stock, and if the price continues to rise, it can be painful to sell shares and pay taxes on those gains.
In these types of situations, it’s helpful to have a financial planner who understands your full situation. For example, with clients who are emotionally attached to their company stock, we help them set up a plan for diversifying their investments. This could mean selling all newly vested shares but keeping the old ones. It could also mean selling old shares over time regardless of what the stock price is doing. Finally, it could mean divesting of the stock completely to fund another important goal like buying a house.
We love helping clients understand their stock compensation plans. If you have questions about your RSUs, please reach out and set up a complimentary introductions call!