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Making Sense of Restricted Stock Units: Terminology, Taxes and More!

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Receiving recognition for your hard work is always a great feeling! You’ve got your paychecks rolling in, perhaps a cash bonus here and there, and things are looking good. What else could you possibly ask for?  Well, for many employees out there, you may have also been awarded Restricted Stock Units, or RSUs, as part of your total compensation package. RSUs can be an exciting addition to your paychecks and cash bonus, but this form of equity compensation can lead to more questions than not as they are quite complex. 

restricted stock units

Below, we’ll explore RSUs in further detail to help you make informed decisions about this type of equity as you navigate your financial journey ahead.

What is a Restricted Stock Unit? 

Restricted Stock Units (RSUs) are a form of equity compensation typically granted to employees in public or late-stage private companies. 

A grant of units represents a promise of a specified number of company stock shares under certain conditions. However, instead of receiving those RSUs immediately on your grant date, you don’t actually own them until your first vesting date.

A simple way to think about RSUs is like you are receiving a cash bonus. However, instead of getting cash deposited into your checking account, your employer gives you company stock. 

Breaking Down RSU Terminology 

Before we delve deeper into RSUs, it’s probably best to first understand some of that terminology mentioned above, like equity, grants and vesting. 

Equity compensation 

Equity compensation refers to a non-cash payout received as an employee which gives you a stake in your company via partial ownership of the business and its profits. 

By gaining equity as an employee, you are incentivized to do your best in your role. The more successful you are in your role, the better off your company will be, and the better off your company is, the more potential for your stock to increase in value. And you know what that means? It translates to more potential money for you should you choose to capitalize on those gains. 

Sounds pretty great for all involved, right? 

Grants

As part of your offer letter with a new employer, you may have been granted, or awarded, a guaranteed number of shares that you will receive in the future should you stay with your company. There’s no cost to you when you are granted Restricted Stock Units.

Let’s say you work for XYZ public company and the following occurred:

  • You were granted $100,000 in RSUs
  • The average price of XYZ stock at the time of grant was $25
  • You were awarded 4,000 RSUs ($100,000 / $25)

However, you won’t have ownership rights or the ability to decide what to do with those RSUs until they have vested.

Vesting schedule

You were just granted RSUs and you’re excited, of course! But, you just read the fineprint in your equity award about a vesting schedule. Now, what’s this? 

Your vesting schedule dictates when you have access to your RSUs and actually own them. 

There are two common vesting schedules:

  • Cliff vesting: the entire allotment of RSUs vest after a specific period of time, which can vary, or once a specific goal or milestone is achieved
    • Example: You were granted 1,000 RSUs. 25% vest after 1 year and the remainder vest monthly (1/48th of the original grant). This would be considered a 4-year vesting schedule with a one-year cliff.
  • Graded vesting: a specific percentage of your RSUs will vest each year for a specified time period
    • Example: You were granted 2,000 RSUs. On a 4-year graded vesting schedule, 500 shares, or 25%, may vest each year.

Once your RSUs vest, their dollar value depends on the stock’s market price on that day. This means the value of your shares can be uncertain until they actually vest, as stock prices fluctuate constantly.

Understanding the Tax Implications of RSUs

In an ideal scenario, you’d simply sell your RSUs once they vest, pocket the money, and move on without tax concerns. Well, you know that’s not the case! In order to understand your RSUs clearly, you need to be aware of the tax implications. 

Tax considerations at RSU vesting 

Once your RSUs vest and become yours at that current market price, you automatically owe taxes at your regular income, or ordinary income, tax rates. 

The good news is that, in most cases, your company will immediately sell some of your shares to cover a portion of the taxes due at vesting. Since RSUs are considered supplemental income by the IRS (just like a cash bonus), the withholding is typically at the supplemental withholding rate. This generally looks like the following:

  • 22% federal withholding for supplemental income under $1,000,000
  • 37% federal withholding for supplemental income over $1,000,000
  • Plus social security and medicare (FICA), and applicable local and state taxes

NOTE: Some companies may let you increase your withholding rate to cover a larger tax bill than what the supplemental withholding would handle. Put simply, if your RSU income and other earned income for the year pushes you into the 32% marginal tax bracket, for example, the 22% withholding wouldn’t be enough. 

As always, an example will help us understand the taxation at vesting further:

  • You were granted 10,000 RSUs at ABC company on 02/01/2023
  • 25%, or 2,500 units, vested on 02/01/2024 when ABC was trading at $28/share
  • You now have $70,000 of taxable income at ordinary income tax rates
  • Your employer withheld 22% ($15,400) for federal taxes and 7.65% ($5,355) for FICA taxes (no additional withholding occurred since you live in Florida, a no income tax state, for this example)
  • Your employer would withhold 742 shares to cover taxes and the remaining 1,758 shares would be deposited into your account for you to decide what to do next (hold vs. sell) 

Tax considerations when selling RSUs 

You’ve accounted for the taxes when your RSUs vest, but the tax implications don’t end there.

Your cost basis in the shares will be their market value when they vest – the same amount that was previously taxed as income (in the example above). 

When you go to sell your shares, any profit or loss (the difference between the fair market value of your stock at the time of vest and your sale price) is reported on your taxes as a capital gain or loss. For the lower long-term capital gains tax rate (up to 20%), you need to hold the shares for at least a year after vesting. Otherwise, if sold earlier, it’s considered a short-term gain (or loss) and taxed at your regular income rate for that year. 

Meanwhile, if you sell your shares immediately upon vest, there is no (or minimal) additional capital gains tax. In this situation, you would only experience the regular income tax upon the vesting of your RSUs. 

NOTE: Be aware of the wash sale rule when selling your RSUs. 

Addressing Common Questions When Awarded RSUs

With a better understanding of RSUs and their tax implications, you may want to think through some additional questions as you plan to incorporate your equity compensation as part of your total financial picture. 

What are the potential strategies with RSUs?

When your RSUs vest, you now have to make the somewhat difficult decision on whether to hold onto them or sell them. Let’s think through some of your options here along with potential advantages and disadvantages of each:

  • Hold onto the shares with the expectation their value will increase over time and sell later for longer-term growth
    • Pro: Your company stock does continue to increase and you made the best decision! 
    • Con: Your company stock drops significantly from the time of vest and you would have been better off selling and taking the cash at that time.
  • Sell the shares immediately upon vest
    • Pro: You take future decision-making regarding the stock out of the picture, there’s no additional taxes to consider, and you can use that cash to put it towards your financial goals.
    • Con: You may have missed out on future upside potential for that specific lot of RSUs. However, if you are receiving future RSU vests, and your stock continues to increase, you will be able to still reap those benefits through ongoing vesting.
  • Do a mix of both – sell some shares and keep some shares
    • Pro: From a behavioral standpoint, you don’t feel like you missed out either way vs. an all-or-nothing approach.
    • Con: Refer to above for both holding on to all shares and selling all shares.

NOTE: A good rule of thumb is to have no more than 10% of your total savings in one specific investment, including your company stock. This could also drive a lot of your decision-making in regards to RSU strategy. 

Do you have RSUs and work for a private company? How are things different?

If you work for a public company, you typically have the option to sell the RSU shares immediately upon meeting the vesting criteria and receiving them, provided you adhere to your company’s trading policy.

Meanwhile, if you work for a private company and your RSUs vest, you could owe taxes but not be able to sell the shares for the cash you’ll need to pay the taxes. 

However, this situation can be avoided due to a double-trigger provision that is often implemented within equity agreements at private companies. If this is the case, you won’t have full control of your RSUs and taxes won’t be incurred until both happen:

  1. The vesting date arrives AND
  2. Your company experiences some sort of liquidity event, such as an IPO or acquisition 

What happens if you leave your company with RSUs?

When your RSUs vest, those shares are yours to keep even if you leave the company.

However, if you quit or are terminated from your position, you forfeit unvested RSUs. 

If you work at a private company and you quit before any liquidity event (like an IPO), you likely can keep the shares that vested before your departure. 

Either way, you should review your equity documents and agreements to confirm before making any decisions. 

Incorporating Your RSUs Within The NewRetirement Planner 

Although you can’t predict the future of your company stock and therefore the value of your RSUs, it can still be helpful to conservatively include them as part of your total financial picture.

You can do just that with the NewRetirement Planner. Follow these steps to incorporate your RSUs in your plan: 

  • STEP 1: Navigate to My Plan > Income > Work and add a job. Enter the gross income received as RSU compensation (generally the FMV price the day the shares vest) and select the same start and stop age.
  • STEP 2: Model the stock account your RSUs go to by adding a contribution for the value you compute for the RSUs to an after-tax account with Capital Gains tax treatment. 
  • STEP 3: If you want to account for the capital gains on the sale of the stock at a later date, enter a Money Flows > Transfer on the date you plan to sell the stock. 

For additional details, refer to NewRetirement’s Help Center

In the end, Restricted Stock Units serve as a wonderful incentive to continue working hard at your company and participate in any future growth. Now that you have the knowledge to navigate RSUs effectively, happy planning! 

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