Restricted Stock Units (RSUs) can be an excellent way to grow your wealth. However, like everything with investing, it’s important to understand how they work, and how they fit into your comprehensive financial strategy before moving forward with them.
The truth is that RSUs aren’t as cut-and-dry as traditional investing opportunities. They have vesting schedules to keep in mind, and can impact your tax planning, as well. Let’s go over what RSUs are, how they work, how they’re taxed, and whether or not they’re a good fit for you!
What Are RSUs?
RSUs are something that a company offers employees as part of their compensation. When an employee is offered RSUs, they’re being offered common stock units from their employer. However, these units don’t actually “become” your stock until they vest. So, when RSUs are first offered to you as an employee, they’re technically just a promise. Your company is promising to give you shares of company stock, or the cash value of those shares.
These stock units have a vesting schedule, and once they vest, they’re considered part of your income. That’s because, when your RSUs vest, they officially become stock that you own. Understanding at what point you own your stock means understanding your company’s vesting schedule for RSUs. Let’s take a look at how some vesting schedules work:
Your vesting schedule is going to be time-based. It’s another way that your company is incentivizing you to stick it out with them for the long-haul. This time-based vesting schedule might be graded, or it could be a cliff vesting schedule. Graded vesting means that your stock is vesting at a few different time periods.
As an employee, graded vesting means a certain percentage of your RSU award will vest after each year of service. For example, if you have a five-year graded vesting schedule, 20% of your RSU grant will vest each year. After year one, you’ll have 20%, after year two, you’ll receive another 20% (for a total of 40%), and so on. This means that after five years, you’ll be fully vested. Alternatively, in this example, you’d earn 25% of your RSUs after your first year anniversary. Then, up until your 4 year anniversary with the company, you’d earn a small percentage of your RSUs each month, until you were fully vested at year 4.
A cliff vesting schedule, on the other hand, is much more straightforward and is a bit all or nothing. 100% of your RSUs vest after a predetermined period of time. For example, you may receive 100% of your RSUs after you’ve been employed with the company for 5 years (meaning if you quit before the 5 year mark, you get nothing).
Ultimately, if you quit your job, or are let go, before your RSUs vest, you lose them. However, if you have other reasons (financial or otherwise) for quitting your job, don’t necessarily let RSU incentives be the only thing that holds you back. You need to weigh the pros and cons of changing jobs or careers carefully.
How Are RSUs Taxed?
RSUs aren’t taxed as part of your income until they vest. Then, when they vest, they’re valued based on the current market price of your shares. This value is part of your taxable income, which means you’ll pay:
- Federal taxes
- Employment taxes
- Social Security & Medicare
- State and Local taxes
Most of the time, companies offer to help make paying taxes on your newly-vested RSUs a little bit easier by giving you the opportunity to surrender a portion of your stock back to the company. This covers any taxes you’d owe under a net-settlement process.
Now that your RSUs have vested, you’re playing a bit of a different ballgame. You officially have stock – which is exciting! – but that also means you need to decide whether to hold your shares or sell them. Holding your shares might mean you’ll owe capital gains taxes on the appreciation of your stock if you sell at a later date.
How Do RSUs Fit Into My Financial Plan?
Having RSUs can be an exciting employee benefit and it’s important to have a plan for how you want to leverage them. When it comes to your RSUs, there are a few things you’ll need to think about:
Remember Trading Windows
Most companies have specific windows where employees can trade company stock. This helps protect them (and you!) against insider trading, and a number of other potential problems. If you have trading windows for your vested RSUs, it’s important to understand when they are, and whether you’ll be notified that you’re in the all-clear to sell or trade your shares.
Focus on a Balanced Portfolio
Although RSUs are a fantastic way to grow your wealth, and can be a great incentive for companies to offer their employees, they pose one big problem:
When you hold too much company stock, you no longer have a balanced portfolio.
Even if your company is doing really well, and your stock values continue to climb, that doesn’t necessarily mean you want to have too much of your portfolio relying on your company’s success. The truth is that nobody can control or predict the stock market. One way you can protect yourself against market ups and downs is by having a well-diversified portfolio. If you have RSUs, make sure they fit into a balanced plan for your investing strategy.
Know How You’ll Pay Your Tax Bill (And If You Have Other Tax Implications)
If your company offers an option to pay taxes on your RSUs up front, that’s great! This can be a helpful way to plan for a potentially large income tax bill come filing season. In cases where this option isn’t available, you’ll need to make a plan for how you’ll cover increased income taxes.
You’ll also need to think through whether or not your newly vested RSUs will push you into a higher income tax bracket. If you’re being offered RSUs, there’s a good chance that you’re already a high-income earner. While that’s great news for you, it can be not-so-great news when it comes to your income taxes.
Many people are at the upper edge of their tax bracket without realizing it. Then, when their RSUs vest and are counted toward their income, they’re surprised when their tax bill increases. Don’t fall into this trap! Understand how your RSUs will impact your taxable income, and what you need to do to plan ahead. This might mean adjusting your withholdings to make sure you’re covered come filing season. It might also mean teaming up with a CPA to discuss your unique tax situation.
RSUs and Planning For the Future
RSUs can be a useful part of your financial plan. Once you move past some of the more technical decisions about your RSUs, like when to sell or how you’ll cover taxes, you can start thinking about how they impact your big-picture financial plan. Let’s say you sell your shares after your RSUs vest, and you now have $45,000 in cash from the sale. How do you want to use this money?
It’s easy to look at RSUs as a kind of incentive or investing tool, but I prefer to look at them as a cash windfall. When you sell (whether it’s immediately after vesting, or several years later), you’re going to wind up with a lump sum of cash. Take some time to determine how you want that money to positively impact your life. A few ideas might be:
- Boosting your retirement savings
- Using the money to fund your child’s college education
- Topping off your emergency savings
- Paying down debt
- Leveraging the cash to start investing beyond traditional retirement savings vehicles
Having a plan for the money that comes from your RSUs before you sell them can help to set you up for long-term financial success.
Need help creating a plan for your RSUs? Contact me today! I’d love to point you in the right direction.