If you work in tech and media it is likely you’ve been granted Restricted Stock Units (RSUs) as part of your compensation package. Being on the receiving end of Restricted Stock Units is a wonderful thing.
Especially if you are a young professional.
Why? 🤔 Because you are likely in an ideal position to take more risks in your financial plan because of your long-term investing time horizon. 💯 You have more time on your side to be an investor and ride out short-term market fluctuations.
Ok, you’re probably looking for a bit more analysis than that quick summary of why RSUs are awesome…so let’s back up.
Let’s begin with what Restricted Stock Units are not:
- They are not stock options. ❌
- You do not have to “exercise” your RSUs. 🙅♀️
- You do not have to compare your strike price with the market price and then decide if it’s the right time to pull the trigger (like you would with Incentive Stock Options, ISOs). 🧮
What exactly are RSUs then?
RSUs are simply your company’s promise to compensate you with company stock as long as you satisfy certain conditions.
Seems simple enough, but having a deeper understanding of the conditions of your specific RSUs will allow you to fully maximize the financial benefit in in owning them.
What conditions are often tied to this equity compensation incentive?
- Minimum length of employment - Most companies require you work with there for minimum amount of time. We often see a 4 year vesting schedule with a 1 year cliff. This would mean that 25% of your RSU's vest one after they were granted, and the rest of them vest proportionately every month/quarter over the next 3 years. At the end of 4 years, all of your shares are vested.
- Performance benchmarks - Performing up to a certain benchmark. This is company/role specific but you can receive RSU's that vest upon the company, your team, or the stock price clearing certain performance hurtles...What might an RSU vesting schedule look like?
So, let’s say you work at a “Company X”,👩💻 and you have 100 RSU’s vesting over the next 4 years. To keep it simple, we'll say that the vesting schedule dictates that you will receive 25 shares of Company X stock each year for the next 4 years.
Again, there is no action step that you have to take in order for you to own those shares when the time comes. Additionally, there is no cost to obtaining those shares.
In other words, you do not have an option. Once the schedule* is set, your RSUs will vest (provided you're still with the company of course.)
Once the vesting schedule has been completed, you simply own the shares that you’ve been granted, and they will sit in your brokerage account like any other stock that you bought on the open market.
Quite simply, RSUs are just another form of compensation. 💰 Maybe you make $225k in base salary, $75k in bonus, and 100 RSUs… Well, just like you don’t have to “pay” anything to obtain this base salary (assuming you put in the time and energy required to hold your position) you don’t have to “pay” anything to obtain these RSU shares when the time comes.
They are simply deposited into your account at the moment (or to be more technical within 30 days) they vest. I always tell clients to think of your RSU’s as if your company is giving you an extra cash bonus and then you immediately are going out and buying that amount of Company stock with the cash…that’s the net effect of being granted RSUs.
Why am I emphasizing that RSU’s are a form of compensation rather than actual stock options? 🤔 Well, for one, because the moment your stock vests, you could sell the shares, realize that money in cash and add it to your bank account. To be clear, whether you should or not is a different conversation entirely!
The point I am making here is that RSUs are intrinsically valuable. There is no cost attached to your RSUs (you don’t pay anything to receive the shares) so you’re always in the “money” when you receive them. Just like your salary or bonus, there’s never a situation where your RSUs aren’t worth something (This is unless the company goes out of business entirely....which is not something we're worried about in the short term with companies like Google, Facebook, Amazon etc.)
This isn’t necessarily the case with stock options, and therefore that is one of the key distinctions of the different types of equity compensation. For example, if you have the option to buy your company stock at $40 per share, and the current market price is $35 per share…well, then your options are effectively worthless because you’d be better off just buying your company stock on the open market just like anyone else. 😐 In that case you would never choose to exercise, and all of your ISOs would be hypothetical.
If you don’t exercise, you never actually get those shares! It's for this reason, that within the industry, RSU"s are estimated to be worth 3-4 stock options on average. (Most people don't have the choice of being granted RSU's or ISO's but this something to keep in mind if so.)
How are RSUs taxed?
From a tax standpoint 🧾 as well, it also makes sense to think of your RSUs as “salary” and not as stock options. As soon as RSUs vest, you become responsible for paying income tax on the shares. Let’s use an example. You make $300k in base salary and you have 100 RSUs that will vest in the current calendar year. When tax time comes around, your taxable income will be $300k plus the market value of your 100 RSUs on the vesting date, because your vested RSUs just stack on top of your other W2 income (again, think of RSUs as a cash bonus that you’re going out and buying company stock with.)
How do you pay income tax on RSUs?
There are different ways of paying the income tax on RSUs when they vest.
- Automatically - Most companies set up “sell to cover” which allows you to pay the taxes automatically from the number of shares you receive.
- Quarterly - You can pay quarterly tax estimates
- Annually - Or you can pay the taxes come tax time
Because you are responsible for the taxes as soon as the RSUs vest, the only tax decision you must make revolves around when to sell. If you sell the stock immediately upon it vesting, well, then, there are no capital gains because you did not hold the stock long enough for the stock to appreciate since you paid the tax for receiving the shares.
Will I pay taxes on my RSUs every year?
Again because it bears repeating and actually more simple than it’s made out to be, you will pay taxes on the RSUs at the time of vesting and at ordinary income rates.
Once the stock vests, you own the stock outright.
In other words, once the RSU vests it turns into actual stock that you own in the exact same way that you own any other stock that you bought on the open market. And just like any other stock that you own, you will generally pay capital gains tax when you sell it relative to its price at the time you “bought” it, in this case, when the stock vests. If that time period is 1 year or more, that gain will be taxed at capital gains rate while if you’ve held the stock for under 1 year, then it will be at ordinary income.
RSUs can seem confusing if you are new to receiving them.
And that is why we designed our Financial Life Plan process. We will help address every aspect of your financial world 🌎 including your equity compensation benefits.
*Refer to your employer’s official vesting schedule for complete and current details. For Educational Purposes Only – This does not constitute a recommendation. 3661203TA_Jul23