The Basics of Restricted Stock Units (RSUs) [Video]by Rob Stoll, CFP®, CFA Financial Advisor & Chief Financial Officer / December 5, 2022
Today we are going to talk about restricted stock units (RSUs).
Restricted stock units, or RSUs, are an employee benefit that many employers offer. This is to incentivize employees to remain with the company for a long time or hit performance goals. It’s really important to understand how they work because they can be a great way to build wealth in the long term.
In this video, we are going to look at how RSUs are granted, how they vest, what happens when they vest from a tax standpoint, and then finally, we are going to look at what you can do with the stock once it fully vests and is yours. There are a lot of details in this video but I have written a comprehensive blog article on the RSU strategy so check that out as well! Now, lets dig into how these work.
The first thing we will talk about is how Restricted Stock Units are granted. Companies will give you an RSU in order to encourage you to work hard, grow the company, and stay for the long term. What they might do, using Jane as an example, they might say, “hey Jane, on January 1, we are going to give you 1,000 shares of RSUs.” Now those have no value the day they give it to her. All RSU grants do is say “hey Jane, we promise to give you 1,000 shares of our stock at some point in the future.”
RSU Vesting Schedules
Once they give you that grant, they will also provide a vesting schedule. A vesting schedule is nothing more than their plan to grant you those 1,000 shares at some point in the future. The most common example we see in companies is for the RSU grants to vest over 3 or 4 years. So if we go back to the example of Jane here, her company might tell her “We are going to grant you 1,000 RSUs but over the course of four years. In two years, 250 of those shares will become yours, and then the next year another 250, and so on until all the RSUs become yours.”
This is a really great way for companies to incentivize employees. Say that stock is worth $10 per share. This grant will be worth around $10,000 when Jane is fully vested. But if the stock price grows to $15 or $20 or $30 dollars in the future, once they vest, they will have a much higher value. Once those shares vest for Jane, the value will be hers. So, it’s important we look at how they are taxed.
If you work at a company that gives stock options, you probably know that the taxes around stock options can be very complicated. The good news with Restricted Stock Units is that taxation is a lot simpler. They do a lot of the leg work for you.
Let’s go back to Jane. Say she got her grant on January 1st and then it’s one year later. She has 250 shares vested. On the day she vested, let’s say the stock is worth $10 a share. So she now has stock worth $2,500. But from a tax standpoint, they treat RSU vesting much like they do your salary. You get your gross salary and then they take out your taxes and deductions that go along with that. So when these shares vest for Jane, she is not actually going to get 250 shares. Her company is going to say “wait a minute, we are first going to withhold some of those shares to pay for federal taxes.” Normally that’s around 22% of all the shares you get. In this case, that’s 55 shares.
Then, if you live in a state with income taxes, they might say, “we are going to withhold state taxes as well.” Here in Illinois, that’s around 5%. The company might withhold another 12 shares in order to pay state income taxes. Finally, when RSUs vest, they are subject to FICA or social security and Medicare taxes. That takes out another 19 shares. What actually happens on the day Jane vests, from those 250 shares, all at one time her company will take out all those taxes and she will get 164 net shares. Those 164 shares, at that point, is money that is hers. That’s really how the taxation works when RSUs vest.
One of the last common questions we get is “okay once I get these shares, what should I do with them?” There are really two options. What we usually recommend for our clients is to sell the shares. The reason we recommend doing this right away is we want to make sure your investments are well diversified and that you aren’t overly concentrated in your employer stock. Jane would get her 164 shares, sell them all, then invest the proceeds into a mutual or exchange traded fund.
Another option is you can keep them for the long term if you think the stock price of your company is going to grow a lot. But, in the future when you go to sell them, you will have to pay capital gains tax on whatever that growth is.
Next Steps For Restricted Stock Units
I hope this video helped you understand the basics of restricted stock units and how taxation of them works. Again, as I mentioned at the beginning, we have a blog post that you can check out to learn even more. If you have questions about this topic or your finances in general, schedule a call with us! We would love to see how we can help you.
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A Guide to Restricted Stock Units
Read this before you get, vest, or sell restricted stock units. There are three stages in the life cycle of RSUs that are granted to you. We discuss the risks, taxation, and when to sell your stock.
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Rob Stoll, CFP®, CFA Financial Advisor & Chief Financial Officer
Rob has over 20 years of experience in the financial services industry. Prior to joining Financial Design Studio in Deer Park, he spent nearly 20 years as an investment analyst serving large institutional clients, such as pension funds and endowments. He had also started his own financial planning firm in Barrington which was eventually merged into FDS.