Understanding the Basics of Restricted Stock Units (RSUs)

In a competitive professional environment, corporations look for ways to compensate key personnel within their workforce. Doing so fosters retention and helps keep highly effective and productive members of the team on board. One of the many ways corporations can reward employees is through equity compensation. Equity compensation is a method of paying employees through the form of equity (shares) in the company in addition to their standard salary and benefits.

Restricted stock units (RSUs) are one of the more common types of equity compensation. RSUs are popular due to their simplicity for both parties (employer and employee). Here are some of the basics of RSUs, key advantages, and important considerations for those participating in these plans.

Grant and Vesting

The two most important dates in an RSU plan are the grant date and the vesting date. The grant date is when the plan participant is granted a specific number of units of company stock. At this point, the shares are still just restricted stock units and are not yet actual shares of the company. These units are held in an account until the vesting period is complete. The vesting date is the next important date in an RSU plan. This is when the units become actual shares of company stock that are available to the employee to sell, hold, or transfer. It is up to them to decide at that point.

The length of the vesting period will vary from company to company. A common vesting period is three years, with an equal number of shares vesting each year. For example, today you are granted 300 RSUs. In one year, you will receive 100 shares; the next year, you will receive another 100 shares; and the year after, you will receive your final 100 shares.

Some plans have a “cliff vesting,” in which no shares will vest until the employee has completed a certain length of service (often one year). After the cliff period has passed, the shares will vest as scheduled. Unvested RSUs will generally be forfeited if you leave the company during the vesting period, with few exceptions.

Tax Implications

RSUs are taxed as ordinary income on the date of vesting, not the grant date. They are taxed as ordinary income based on the fair market value of the shares on the date they vest, regardless of whether the employee sells them that day. Most RSU plans have an automated tax withholding feature that automatically sells a certain number of shares to cover the taxes owed at vesting, similar to the automated tax withholding on your pay stub. However, it is important to note that this tax withholding may not be sufficient to cover your tax bill, depending on your other income sources and the specifics of your tax situation.

Another important note about taxes on RSUs is that the value of the shares on the vesting date becomes your new cost basis. Any subsequent gain or loss from a future sale of the shares will be based on this cost basis from the vesting date. For example, if the shares are worth $10 on the vesting date and you sell them for $12/share, then you will have to pay taxes on the $2/share difference. Whether you held the shares for more or less than 365 days will determine whether you pay the short-term or long-term capital gains tax rate. The long-term capital gains tax rate is far more preferable (lower) than the short-term.

Summary

RSUs are a relatively simple form of equity compensation, but each plan is different and has its own nuanced approach. Review the plan documents and specifics carefully, work with your tax preparer or accountant to discuss the tax implications of your RSU plan, and work with a trusted fiduciary financial planner to discuss how these RSUs fit into your overarching financial picture. RSUs can be a great tool to maximize your earning and wealth-building potential in your job.

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Zac Pohlenz, CFP®

As a Wealth Advisor, Zac works every day to help clients reach their financial goals, and finds it satisfying to know that he has helped someone gain a new perspective that can help change their life.