Restricted stock units (RSUs) are a popular form of equity compensation offered by companies to attract and retain talent. Essentially, they represent a promise to grant an employee shares of company stock at a future date, subject to certain conditions. Understanding how RSUs work and your options when they vest is crucial for making informed financial decisions.
What are Restricted Stock Units (RSUs)?
RSUs are not actual shares of stock until they "vest," meaning the time which they become the receiving employee’s to own. Many times, RSUs have a predetermined vesting schedule, which outlines the timeframe and conditions under which they become vested. This schedule can be based on time (e.g. cliff vesting after one year, followed by monthly vesting over the next three years) or performance-based (e.g. vesting upon achieving specific performance goals).
Unlike stock options, which require employees to pay an exercise price to purchase shares, RSUs do not require any upfront investment from the employee.
What Happens When Your RSUs Vest?
Upon vesting, RSUs are considered ordinary income, and employees are responsible for paying taxes on the fair market value of the vested shares at that time. This typically involves federal and state income taxes, as well as potential payroll taxes. Often, taxes are withheld by selling shares (i.e. if 100 shares vest and the recipient is in the 22% tax bracket, 22 shares are automatically sold to cover taxes and 78 shares will be awarded to the recipient). Once RSUs vest, an individual has several options for handling them:
1. Sell the Shares:
This option allows the employee to immediately convert vested shares into cash. This can be helpful for meeting financial needs, diversifying your portfolio, or taking advantage of other investment opportunities. When the vested shares are sold, the employee is responsible for capital gains taxes on the difference between the sale price and the market value of the shares on the date they vested.
2. Hold the Shares:
Holding allows the employee to benefit from the company's future growth and potential share price appreciation. By holding the shares, the employee can potentially defer capital gains taxes until you decide to sell them. However, the concentration of company stock could result in outsized portfolio losses if it were to experience a price decline. It is important to consider the overall diversification of your portfolio when choosing to hold the RSUs.
3. Reinvest the Shares (if offered):
Some companies offer a dividend reinvestment plan (DRIP) for employee stock holdings. This allows the employee to automatically reinvest dividends into additional shares of the company stock, potentially accelerating wealth accumulation. DRIPs may involve transaction fees, and reinvesting dividends still trigger ordinary income tax on the dividend amount.
Making the Right Choice
The best option for handling vested RSUs depends on an individual’s financial situation, risk tolerance, and investment goals.
If there is a short-term need for cash, or belief that asset diversification is essential in a portfolio, selling and diversifying the cash may be the best option.
Consulting a financial advisor can provide personalized guidance based on specific circumstances to manage your vested RSUs.
Reach out to discuss how a financial plan could assist in understanding RSU options to maximize their potential benefits for your specific situation.
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