Unlock the Potential of Your RSUs

Does your employer provide you with restricted stock units (RSUs)? Ever wonder how you can use RSUs to your benefit while managing the risks? Ever wonder how you can manage RSUs to make the most of your life? The goal of this article is to provide you with a crash course on how to master your RSUs. In this article, I discuss the following:

• What is an RSU?

• What is RSU vesting?

  • Why is knowing the RSU vesting schedule important?

• How are RSUs taxed?

  • How are RSU taxes paid?

  • What tax is owed when you sell the stock?

• Essential items to review when managing RSUs

• What are the pros and cons of RSUs?

• What are the strategies for managing RSUs?

What is a Restricted Stock Unit (RSU)?

Restricted stock units (RSUs) are a type of equity compensation issued by a company to its employees. They represent the right to receive a certain number of shares of the company's stock at some future date, subject to certain restrictions. Companies commonly use RSUs to provide long-term incentives to their employees, as they align the interests of employees with those of the company and its shareholders.

RSUs differ from traditional stock options in that they do not give the recipient the right to purchase shares of the company's stock at a predetermined price. Instead, they are simply a promise to deliver shares of the company's stock to the employee at some point in the future, typically based upon specified conditions. The employee has ownership rights once the shares are vested or once the employee meets the RSU's requirements. Here is a brief breakdown of the process:

• RSUs are granted. The grant date is when your company pledges to give you a certain number of "restricted" shares. RSUs are often awarded based on employee performance, and employers typically grant RSUs after an employee's annual performance review.

• RSUs are vested. These shares are earned over a vesting period, often over several months or years. The employer typically ties RSU vesting to specific performance goals. On the vesting date, the shares are no longer "restricted," and you may do what you wish the stock. At vesting, these shares will be seen as income for tax purposes. The amount of income earned is based on the number of shares vested and the stock's market price.

What is RSU Vesting?

Shares are "vested" when you have earned the right to keep the shares. During the vesting period, the employee still has a substantial risk of failing to meet the RSU's conditions. Thus there is still a substantial risk of forfeiture during the vesting period, and no income is earned until the shares vest.

The company may place several types of restrictions on the RSUs. These restrictions may require the employee to work for the company for a certain period before the shares are delivered. Other conditions may include performance-based outcomes, which need the employee to meet specific performance goals before the stock vests. The most common vesting requirement is based on time spent working for the employing company. Typically RSUs based on tenure are tied to specified periods. For example, a vesting schedule may define 8.3% of the shares vesting each quarter for twelve quarters.

An RSU Vesting Schedule Example

Employees who have multiple years of employment will likely have numerous RSU grants. This means they will simultaneously receive shares from several grants over the following months and years. An RSU vesting schedule helps you see how many shares by date will become vested (and thus income). Let's look at an example to understand the importance of knowing your RSU vesting schedule.

Let's assume Jamie, a marketing professional for a large, publicly traded company, has received grants over the previous three years as follows:

• 4/30/22 grant date for 1,025 shares

• 4/30/23 grant date for 775 shares

• 4/30/24 grant date for 1,525 shares

On May 1, 2024, Jamie is trying to understand how many shares will vest over the coming months and years. Per her employer's RSU agreement (the document which outlines the vesting schedule and requirements), shares granted vest over three years, with 8.33% of the grant vesting each quarter (a total of 12-quarter vesting periods). Shares from the most recent grant award begin vesting immediately in the next quarter. The shares vest so long as Jamie remains an employee on the vesting date.

Jamie will still receive shares from a grant received in 2022 and 2023, in addition to her most recent grant award. The chart below illustrates the number of shares to be vested over the next three years, assuming she remains an employee of the company.

From the vesting schedule outlined above, Jamie will receive 277 shares from her grant awards. She could then multiply those shares by an estimated share price to determine the income earned from the vested shares, and she could begin to plan her taxes and cash flow from there.

Knowing your vesting schedule is essential. Knowing your vesting schedule will help you make decisions with regard to the following:

• Cashflow

• Taxes

• Separation from service

• Goal formation and attainment

How Are RSUs Taxed?

There are tax implications for the employee when RSUs are vested and delivered, as the value of the shares is considered income for tax purposes. This is a common point of confusion. Many people associate income with receiving cash. However, when an RSU is vested, you don't immediately see any money in your bank account (unless you sold the shares immediately on vesting). However, the stock received falls under the IRS's definition of income. Vested RSUs can be considered cashless or phantom income. You are still responsible for paying the tax because this is income you earned.

With RSUs, the employee experiences a taxable event when the shares are vested and delivered. The fair market value of the shares is treated as income. Thus you will owe:

• Federal income tax

• Employment tax (Social Security and Medicare Tax - subject to income thresholds)

• State and local tax

For federal income tax, the tax rate will depend on the employee's ordinary income tax bracket. Federal ordinary income tax rates range from 10% to 37%, depending on the employee's taxable income. State taxes are dependent on each state. And employment tax is 7.65%, subject to income thresholds.

How Are RSU Taxes Paid?

A company may offer several ways to pay taxes at delivery or use one required method. If you are an employee of the company, your employer must withhold taxes (much like they withhold taxes from your paycheck).

The most common practice is taking an amount from the newly delivered shares by relinquishing stock back to the company. This method allows the company to hold or "tender" shares to cover the withholding taxes. When the company withholds shares, it is a convenient option for the employee, as the employee doesn't have to come up with the cash out of pocket to pay the withholding tax. Your W-2 will show the RSUs as income, and the W-2 will reflect any income tax withheld. Whatever is withheld is used as a credit for your income tax return (your 1040).

Companies typically withhold at a rate different from your W-4 elections. They will typically withhold at the IRS supplemental income rates. For the 2023 tax year, that is 22% up to $1 million in supplemental earnings and 37% for wages over $1 million.

The supplemental tax rates more than likely don't match your actual federal income tax rates. The difference between the withholding rate and the real income tax rate is why it is common for folks to owe taxes when they file their return. Without proper planning, this can be an unpleasant surprise. If you expect to owe additional federal taxes at the end of the year, consider adjusting your payroll withholding via your W-4 elections or setting aside money to pay the tax bill.

Here is an RSU example where the individual receives a surprise tax bill.

• Jamie received 1,000 shares of vested employer stock at $100 per share on July 1, 2022. They earn $100,000 in income ($100 per share x 1,000 shares = $100,000).

• Based upon the supplement withholding schedule, their employer withholds $22,000 of the employee's RSU income (22% x $1,000).

• Jamie received a W-2 in January 2023 reflecting the $100,000 income and $22,000 income tax withheld.

• Jamie prepared her income tax return in March 2023. They find their taxable income places them in the 37% tax bracket. Their tax due from the RSUs is $37,000.

• Jamie has a $15,000 surprise tax bill due to the IRS. They will need to come up with this cash out of pocket.

Proper planning is needed to help avoid this situation. To avoid this situation, Jamie could save money ahead of time or increase their withholdings on their W-4 elections with their employer.

Are you trying to figure out where best to save your hard-earned money? Download our 18-point checklist, which outlines the accounts you should consider if you want to save more.

What Tax is Owed When You Sell the Stock?

In addition to ordinary income tax, employees may also be subject to capital gains tax when they sell the shares they receive from RSUs. Even if you did not pay anything to acquire the stock, your basis is equal to the income you reported when the shares were vested (plus any money you paid out of pocket to purchase the stock).

If the employee sells the shares within one year of the vesting date, the short-term gain or loss will be taxed at the employee's ordinary income tax rate. If the employee holds the shares for more than one year before selling them, the gain or loss will be taxed at a lower rate. The long-term capital gains tax rates range from 0% to 20%, depending on the employee's ordinary income tax bracket (and they may be subject to the Net Investment Income Tax).

Here is an example where the individual receives RSU shares and sells the shares with a long-term capital gain.

• Jamie's company grants Jamie 1,000 shares. The stock will vest equally over the next four years. There is no taxable event on the grant date for Jamie.

• Jamie received 250 shares of their company's stock from vesting in year 1. They received the shares at $20 per share. Their basis is $5,000 (or $20 per share). They will owe income and applicable employment tax on the shares vested. Jamie's year 1 W-2 and 1040 will reflect the RSU income.

• Jamie received 250 shares of their company's stock from vesting in year 2. They received the shares at $30 per share. Their basis is $7,500 (or $30 per share). They will owe income and applicable employment tax on the shares vested. Jamie's year 2 W-2 and 1040 will reflect the RSU income.

• Jamie received 250 shares of their company's stock from vesting in year 3. They received the shares at $40 per share. Their basis is $10,000 (or $40 per share). They will owe income and applicable employment tax on the shares vested. Jamie's year 3 W-2 and 1040 will reflect the RSU income.

• Jamie received 250 shares of their company's stock from vesting in year 4. They received the shares at $20 per share. Their basis is $5,000 (or $20 per share). They will owe income and applicable employment tax on the shares vested. Jamie's year 4 W-2 and 1040 will reflect the RSU income.

• Jamie does nothing in year 5. Jamie has no taxable event in year 5.

• In year 6, Jamie sold the stock for $50 per share. Jamie will have a $22,500 long-term capital gain. Depending on Jamie's income, the gain will be taxed between 0 and 20% (Net Investment Income Tax may apply).

The chart below visually explains Jamie's RSU situation.

A Recap of How RSU Taxes Work

• RSUs are taxed as income when they are vested.

• Suppose the shares are sold immediately upon vesting, and there is no difference in basis and sale price. In that case, there will be no capital gains tax and only income and employment tax.

• If the employee holds the shares past the vesting date, the stock's prices will likely fluctuate. Keeping the shares for some time will result in a capital gain or loss. A gain or loss is taxed based on the capital gain or loss tax rules.

Essential Items to Review When Managing RSUs

First, understand the terms of the RSU plan. Employees need to understand the details of their RSU plan, including any vesting requirements and the potential tax consequences of receiving the shares. Understanding the plan's terms will help employees make informed decisions about the RSUs and how to plan for the future.

Second, consider the potential tax implications. The value of RSUs is considered income for tax purposes when vesting. RSUs can result in a significant tax burden for the employee, particularly if the value of the shares has increased significantly. Employees should consider the potential tax implications of receiving RSUs and plan accordingly.

Third, consider diversifying your portfolio when appropriate. Employees should consider diversifying their portfolio by holding a mix of stocks, bonds, and other investments. Diversification can help reduce the overall risk of an investment portfolio and can help to protect against the potential loss of value in any particular asset.

Fourth, develop a financial plan. Employees should consider creating a financial plan that includes a budget, savings goals, and investment strategies. A financial plan can help employees to manage their money effectively and to achieve their long-term financial goals. This plan should include the following:

• Determine the schedule for your RSU vesting and the potential tax implications.

• Check if your tax withholding or savings is sufficient to cover your RSU tax liability and make a plan if it is not.

• Decide how much of your company stock you want to hold and use that to guide your strategy for selling RSUs as they vest.

• Consider using your RSU income to maximize contributions to tax-deferred accounts and charitable giving to reduce taxes.

Last, consider seeking professional advice. Employees may seek professional financial advice to help them make informed decisions about their RSUs and develop a personal financial plan that meets their individual needs and goals.

By understanding the terms of their RSU agreement, considering the potential tax implications, diversifying their portfolio, developing a financial plan, and seeking professional advice, employees can effectively manage their RSUs and make informed decisions about their financial planning.

What are the Pros and Cons of RSUs

There are pros and cons to receiving RSUs as part of an employee compensation package. Some of the pros of receiving RSUs include the following:

• Simplicity: RSUs are relatively straightforward to understand compared to other types of equity compensation.

• Potential for appreciation: If the company's stock price goes up, the value of the shares earned will also increase, providing the employee with a potential windfall.

On the other hand, there are also some potential cons to receiving RSUs:

• Tax implications: As mentioned earlier, the value of the RSUs is considered income for tax purposes when they vest. RSUs can result in a significant tax burden for the employee, particularly if the value of the shares has increased significantly.

• Vesting requirements: Tenure contingent RSUs require the employee to continue to work with the same employer with some time to receive vested stock. Tenure-driven vesting requirements can sometimes become a hurdle for employees to leave their current employer. On the other hand, some RSUs have vesting requirements tied to the company or department performance before the shares are delivered. These vesting requirements can create uncertainty for employees, as they may not know when they will receive the shares or how much they will be worth.

• Lack of control: With RSUs, the employee has no control over when the shares are delivered or what price they will be worth when they are delivered. Lack of control can make it difficult for employees to plan for the future.

• Downside Risk: Shares held from RSUs after vesting are subject to market price fluctuation. Just as there is a potential for stock price appreciation, the share price may decrease due to poor performance from the company or broader economic challenges.

RSU Strategies

Employees can consider several personal financial planning strategies when they receive restricted stock units as part of their compensation package.

When RSUs vest, you receive company shares instead of cash. Whether you realize it or not, you have an essential decision - do you keep or sell the vested shares? When RSUs vest, ask yourself, "Would I buy my employer's stock today with cash?" If the answer is "No," you gave yourself a solid reason to consider selling the stock upon vest. Selling the stock manages your exposure to your employer's stock price performance.

Employees receiving RSUs should be hyper-aware of how much of their net worth depends on their employing company's performance. Not only is your income reliant upon the company, but your net worth grows more and more dependent on your employer's performance if a growing share of your assets comprises company stock. When the overall dollar amount of company stock grows to be a significant portion of your net worth, you should actively consider ways to reduce your portfolio's investment risk. Managing investment risk can be done in several ways, including:

• Consider selling out of company shares and using the proceeds to increase portfolio diversification. Investigate using the proceeds to help improve your savings to tax-deferred accounts (i.e., IRAs or 401ks) or taxable accounts. Using the proceeds for tax-deferred accounts can help offset the tax costs associated with the vesting of RSUs or capital gains tax due from selling shares. Or, consider using the proceeds to enjoy and pay for a long-held goal (i.e., sabbatical, vacation, new car, etc.).

• If you cannot sell due to insider rules set forth by SEC Rule 16(c) or obligations outlined in your employment agreement, consider diversifying the rest of your portfolio by:

  • Purchasing or reallocating your portfolio to low correlating assets

  • Purchasing or reallocating your portfolio to lower-risk assets

  • Avoiding margin or leveraged positions in your portfolio

  • Using advanced hedging strategies

The Takeaway

In conclusion, RSUs are a type of equity compensation issued by companies to their employees that represent the right to receive a certain number of shares of the company's stock in the future, subject to certain restrictions. They are a way for companies to provide long-term incentives to their employees. Still, they also come with tax implications and may have vesting requirements that create uncertainty for employees. It is crucial for employees to understand the terms of their RSU agreements and to consider the potential pros and cons before deciding how to incorporate them into their financial plan.

I help working professionals make the most of their finances. If you are navigating your finances and trying to understand how your RSUs can enable you to achieve your goals, feel free to place a complimentary 30-minute meeting on my calendar. In that meeting, we can discuss your objectives and situation.

Looking for personal guidance?

Schedule a free call with Nate Baim, MBA, CFP®

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