The Basic Concept
A restricted stock unit is a company benefit that gives an employee company stock. The reason why it is called restricted is that an employee has to wait for the grant to be vested. This vesting period can be tied to an employee’s performance or time with the company. The most common vesting period is time with the company though.
One great thing about RSUs is that they always carry some type of value. With other types of stock options, the exercise price can be higher than the market value of stock, and then the stock option are not worth anything.
For example, let’s say Company XYZ offers an employee 100 RSUs on May 15th, 2021. If the price of the stock is worth $25 on Jan 15th, the value of the RSUs are worth $2,500, but the employee can’t exercise the RSU until May 15th. So it doesn’t matter what the price is until the actual vesting date.
If the price of the stock dips to $20 per share on May 15th, then the value that the employee will get is $2,000.
Typically, an employee is going to receive a block of RSUs that will be given out gradually over time.
For example, an employee might receive 400 RSUs that grants 25% of the shares every year. So it might look like this (this will be different from employer to employer):
- RSU Grant 400 Grants
- 100 Units on 1/15/2020
- 100 Units on 1/15/2021
- 100 Units on 1/15/2022
- 100 Units on 1/15/2023
The value of the RSUs will be determined by the price of the stock on the vesting day. A company’s stock can be volatile and the price of a stock can dip, but RSUs always have value associated with them as long as the company is still around.
If we look at the example above with the following exercise prices, we can see what value a person could receive.
- RSU Grant 400 Grants
- $25 on 1/15/2020
- $30 on 1/15/2021
- $15 on 1/15/2022
- $15 on 1/15/2023
In this case, the person would have $8,500 in compensation. If the person was able to sell all shares at $30, then the person would have $12,000 in compensation. People can’t control the price of the stock, so it’s best not to get our hopes too high on receiving a particular amount.
Once the RSUs become vested and exercised, typically the best thing to do is to sell the stock and diversify the cash into other investment choices that are more diversified.
How are RSUs Taxed
When its comes to taxes, RSUs will be taxed in the following areas:
- Federal Tax
- State Tax (Depends on someone’s state)
- Medicare Tax
- Social Security Tax
Whatever value that someone receives from exercising their RSUs, they will get taxed on that amount. If someone received $12,000 in value from exercising their RSUs in a year, they could have a tax situation like this as an example:
- Federal Tax (24%) – $2,880
- State Tax (9%) – $1,080
- Medicare Tax (1.45%) – $174
- Social Security Tax (6.2%) – $744
- Total Tax – $4,878
- Take Home – $7,122
It’s also important to know that employers typically only withhold 20% for tax purposes. Come tax time, this is going to cause someone to owe taxes, so it’s wise to know what the true tax liability is so they don’t get an unpleasant surprise like owing thousands of dollars in taxes and not being prepared for it.
It’s also important to review the 1099-B and Form 8949 to ensure that the cost basis is correct if someone decides to hold onto the stock and sell at a later date.
Don’t assume that the employer or the custodian of the RSUs is going to give accurate numbers to the IRS.
What To Do With The RSUs Once They Become Vested
Once someone exercises their RSUs, they can either decide to take the stock, or they can decide to cash out.
What is the best decision is really based on someone’s goals and how well the company is doing. With my clients, I typically run investment reports to see what is the best option for the client, but here are some other questions that people should think about.
- Do my stock options make up more than 5% of my net worth?
- What is the upside of holding onto the company stock?
- What is the downside of holding onto the company stock?
- Is there a better option for me outside of holding onto the company stock?
- Can I use the proceeds to help me fund another goal?
- If I decide to hold onto the stock, can I keep good records of the cost basis?
- Am I on track with my retirement goal?
One way to look at RSUs is just to think about it as a cash bonus that can be used to keep in stock or cash, and should be used as a tool to help reach someone’s financial goals.
The goal of life is not to accumulate as much as we can, but to live as much as we can. We can ensure that we live as much as possible by having our goals written down, having a plan, and then executing on that plan, while adjusting the goals and plan as needed.
As always, please do your research before you make any changes with your financial plan, or consult a professional like myself to help you out.
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