Employers, especially many startups, use different compensation options to attract and keep top performing employees. A common alternative is equity compensation, which allows employees to share in the ownership and the profits of the company. Equity compensation takes different forms such as stock options, restricted stocks, and deferred comp. Today, most companies are resorting to the use of restricted stock unit (RSU) as a significant compensation package. If you are fortunate to receive RSUs from your employer, you should understand the basics of this corporate perk. Here is all you need to know about Restricted Stock Units (RSUs) and some essential tips on how to manage them.
What are Restricted Stock Units (RSUs)?
A restricted stock unit (RSU) is a type of equity compensation given by an employer to an employee in the form of company stock. Employees receive RSUs through a vesting plan and distribution schedule after achieving required performance milestones or upon remaining with their employer for a particular length of time. RSUs give an employee interest in company stock but they have no tangible value until vesting is complete.
Companies issue restricted stock units according to a vesting schedule.
The vesting schedule outlines the rules by which employees receive full ownership of their company stock. The restricted stock units are assigned a fair market value when they vest. Upon vesting, they are considered income, and often a portion of the shares is withheld to pay income taxes. The employees receive the remaining shares and can sell them at their discretion.
Grant Date and Vesting Date
As an employee, you should be aware of these essential RSU dates. The grant date is the date when the company pledges the shares to you.
You only own the shares when the granted shares are ‘vested.’ The vesting date when the employer transfers the full ownership of the shares to you. At that point, the stock becomes fully vested, and they are owned by the employee.
Even though RSUs offer employees ownership in company stock, they usually don’t have a tangible value before vesting. When vesting is complete, the restricted stock units are valued according to the fair market value at that time.
Taxes on RSUs
The fair market value of your vested RSUs is considered personal income in the year of vesting. Typically, companies withhold part of the shares for federal and state income taxes. The remaining shares are given to the employees. At this point, you can decide to keep or sell them at your wish. If your employer doesn’t withhold taxes for your vested shares, you will be responsible for paying these taxes during the tax season.
Once the RSUs are converted to company stock, you become a shareholder in your firm. You will be able to sell some of these shares subject to companies’-imposed trading windows and executive limits. If the stock price goes up after vesting you will need to pay either short-term capital gain taxes for shares held less than a year from date or long-term capital gains taxes in shares held longer than one year.
Being a shareholder in your firm could be very exciting. If your company is in great health and growing solidly, this could be an enormous boost to your personal finances.
However, here is the other side of the story. Owning too much of your company stock could impose significant risks to your investment portfolio and retirement goals. You are already earning a salary from your employer. Concentrating your entire wealth and income from the same source could jeopardize your financial health if your employer fails to succeed in its business ventures. Many of you remember the fall of Enron and Lehman Brothers. Many of their employees lost not only their jobs but a significant portion of their retirement savings.
As a fiduciary advisor, I always recommend diversification and caution. Try to limit your exposure to your employer and sell your shares periodically. Sometimes paying taxes is worth the peace of mind and safety.
Receiving RSUs is an excellent way to acquire company stock and become part of your company’s future. While risky owning RSUs often comes with a huge financial upside. Realizing some of these gains could help you build a strong foundation for retirement and financial freedom. When managed properly, they can help you achieve your financial goals, whether they are buying a home, taking your kids to college or early retirement.
If you’d like to discuss how to make the most out of your RSUs, please feel free to reach out and learn more about our fee-only financial advisory services. We will meet you in one of our offices in San Francisco, Oakland, Walnut Creek, and Pleasant Hill areas. As a CFA® Charterholder with an MBA degree in Finance and 15+ years in the financial industry, I am ready to answer your questions.
Stoyan Panayotov, CFA
Founder|Babylon Wealth Management