Restricted Stock Units (RSUs) are an increasingly popular — and valuable — form of equity compensation. Here we answer common questions about RSUs.
What are restricted stock units?
A restricted stock unit (RSU) is a type of compensation in the form of company shares. An employer issues RSUs to employees, giving them interest in company stock. When issued, they contain some form of restriction, typically a time-based restriction through a vesting schedule (often four years). Once vested, RSUs are assigned a fair market value and are considered income.
There are two important dates when it comes to RSUs: The “grant date,” or date when your company promises the RSU, and the “vesting date,” at which time you hold the shares.
Let’s say you receive 1,000 RSUs on the grant date with a four-year vesting period. In this example, one quarter of those shares — 250 total — vest every year.
How are RSUs different from stock options?
Stock options allow you to purchase equity in your company at a determined price within a certain window of time. Just as the term indicates, you have the option — not an obligation — to purchase shares.
RSUs are different in a couple of ways. For starters, there is no transaction or stock pricing involved. A company promises to give an employee a certain number of shares once they fulfill a particular requirement (such as remaining with the company for a specified amount of time). RSUs also always have some value based on the underlying shares, unlike stock options.
When must you pay tax on RSUs?
There are three potential tax implications with restricted stock units that you should be aware of: withholding taxes, short- or long-term capital gains, and getting pushed into a higher tax bracket by your vested RSUs.
Withholding taxes: The value of shares on the vesting date are subject to ordinary income tax in the year they vest. Most employers will withhold compensation taxes on vested shares. In this case, the company would tender the number of shares required to cover the withholding tax, and whatever shares are left would pass to you.
Capital gains tax: If shares are held beyond the vesting date, capital gains are realized when those shares are sold. Any growth in value after the vesting date is taxed at capital gains tax rates in the year you sell those shares.
Higher tax bracket: You must include the full value of vested RSUs as ordinary income in the year of vesting, and this may put you in a higher bracket.
What are some disadvantages to RSUs?
There are a few disadvantages to be aware of. For starters, they don’t pay dividends. They also don’t come with voting rights. Lastly, because they’re not considered to be tangible property, RSUs aren’t eligible for the Internal Revenue Code 83(b) election that allows an employee to pay taxes on the total fair market value at the grant date.
Can you sell your shares?
Once RSU shares have vested, you own them, which means you can save them, cash them out, gift them to someone else, or move them to another institution.
What happens to RSUs if you leave the company?
If you separate from your employer for any reason — you quit, are laid off, or retire — vesting stops. However, some employers will offer accelerated vesting in some instances such as part of a retirement or severance package.
How do RSUs fit into your financial plan?
It’s important to look at RSUs as you would any other investment because just as any other investment, RSUs do come with risk. While it’s natural to want to profit from your company’s success, whether you hold or sell your RSUs once they vest should be considered in the context of your broader financial plan.
A good rule of investing is to remain as diversified as you can to limit risk, and company shares aren’t exempt from this. Work with your wealth advisor to consider the best plan for incorporating RSUs into your investment strategy.
RSUs can be a valuable part of accumulating wealth, but like any other investment opportunity, they require thoughtful planning. We can help you navigate and develop strategies for these and other benefits offered by your company. Contact us today.