Outside of basic salary, employers have many ways to rewards and retain employees.
This can come from incentives such as stock options, profit sharing and performance bonuses — or restricted stock units, which will be the focus of this post. Restricted stock units, or RSUs, are simply a part of an employees compensation package. Instead of a cash bonus or raise, an employer may grant restricted stock units to the employee. There are three basic characteristics to an RSU– the grant, the restriction until a future date, and the vesting date.
In this post I will uncover the basic concepts and what you need to know.
From an employer’s view, restricted stock units are a future promise. It’s a way to retain key employees, keep them motivated and ultimately stay with the company. This can be a win-win for both the employer and the employee. The employer is promising a future benefit in return for the employee to help the company grow. On the flip side, if the employee leaves before vesting, the stock is forfeited. If the employee stays with the company, they get to enjoy the future benefit of company stock — hopefully appreciated company stock. The employer benefits by retaining talented employees on their team and the employee is satisfied because they receive ownership and value in the company.
I should also note that restricted stock units almost always carry a value, unlike stock options. Stock options granted to employees can lose almost all their value in the event of a falling stock price. RSUs still carry a value even if the stock price drops. Let’s dig into how restricted stock units work in real life.
As I touched on earlier, RSUs have three components — the grant date, the restriction or vesting period and the vesting date.
So how does all this work in the real world?
Let’s say an employer awards 2,000 restricted stock units. This is considered the grant. At the time of grant, the share price is $25.00 and the RSUs have a vesting schedule of 4 years. This means the employee must stay with the company for 4 years in order to receive the stock. The company is making a future promise of $50,000. However, this amount will fluctuate with the actual value and performance of the stock price. If the stock rises to $50.00 on the vesting date after 4 years, the value of the RSU would be $100,000. If the company doesn’t perform well over those 4 years and the stock price drops to $15.00, the value of the RSUs would be $30,000.
As you can see, both the employee and the company hope the shares increase over the vesting period. With hopes that the share price enjoys future growth, the company may suffer from uncontrollable and unforeseen economic events. Even if the share price doesn’t perform as expected, RSUs still have a value upon vesting, as long as the company is still operating.
You received an RSU grant and stayed with your company for the full vesting period, great! Now what? There are things to consider at this point, such as your financial goals, and how much company stock you already own, which will be a future topic. For now, Im going to cover what happens when your restricted stock units vest.
First, the good news. You are now an owner of company stock and can do what you want with it. Hold it and enjoy potential growth and dividends. Sell it and deploy the cash elsewhere.
Now for the bad news, but not the end of the world. Taxes. Once the vested shares are delivered to you, you are taxed on this amount. This is considered compensation in the year the RSUs vest. This amount is subject to federal, social security, medicare, and any state and local tax. You are responsible for paying taxes. Typically a company will offer a few options to withhold taxes. Most companies will withhold shares at vesting to cover the tax liability, but this may not cover it entirely. You could also have the option to pay from your own cash flow, or sell shares to cover taxes.
How much tax is owed on RSUs? To calculate the tax liability, let’s extend on the example above and assume the tax rate for this person is 24%.
After 4 years, the 2,000 shares of RSUs vested with the stock price at $50.00. The first step is to determine the taxable income, which is $100,000.
Restricted Stock Units (2,000) x Stock Price at Vest ($50) = Taxable Income ($100,000)
Next, determine the tax liability. At the 24% tax rate, $100,000 of taxable income would result in a tax bill of $24,000.
Taxable income from RSU ($100,000) x Tax Rate (24%) = Tax Owed ($24,000)
Consider this graphic of what a 4 year vesting schedule from grant to vest looks like:
The best course of action to take with company shares is to figure out how they fit into your financial plan. You should have a reason holding company shares and be sure it aligns with what you are wanting to accomplish financially. With company stock, an important consideration is concentration risk. Your employer provides financial stability for you and your family today. If you rely on company stock to provide for your future as well, you could be putting too many eggs in one basket. As a rule of thumb, once a single position approaches 10-15% of investable assets, it might be time to consider diversifying.
Restricted stock units can be a valuable part of your compensation plan and future wealth. It’s important to understand how RSUs operate and what to expect. In a future post, I will dig into strategies and opportunities with RSUs. In the meantime, if you have questions about RSUs or your financial plan, let’s chat!