Should I still participate in my company’s Employee Stock Purchase Plan- Even When the Stock Price is Trending Down?

Tech stocks have had a terrible year thus far. So far this year, the tech-heavy Nasdaq Composite Index is down 23%. Among the worst-hit have been Amazon.com (-25%), Tesla (-32%), Meta (-42%), Zoom (-40%), and Shopify (-74%). We’ve been hearing from so many of you about whether to continue to participate in your company’s employee stock purchases plan (ESPP) when the company stock is declining.

Using the Apple ESPP to illustrate how it works

Essentially, a company that offers an employee stock purchase plan is giving its employees the option to buy the company stock at a discount. Let’s use the Apple ESPP as an example. Suppose your base salary is $200,000. You can contribute up to 10% of that salary – in this example up to $20,000 (ESPP contributions are capped at $25,000 per year, based on the full fair market value of the stock). 

At the start of each purchase period, which goes for 6 months, Apple will withhold the percentage you elect. At the end of each purchase period, they will use the funds withheld over the prior 6 months to purchase stock at a discount. The amount you pay for the shares is the lower of two prices—the offering date price or the purchase date price—plus an additional 15% discount. Apple has their 2 purchase dates as January 31st and July 31st. 

The amount you pay for the shares is the lower of two prices—the offering date price or the purchase date price—plus an additional 15% discount.

Here is an illustration that shows what the timeline for Apple’s ESPP looks like.

Note: Apple’s offering period and purchase period are the same, though that’s not always true. 

In this example, if you had participated between August 1st, 2021 and January 31, 2022, you would be purchasing at a discount on the lower price from August 1st. On January 31, Apple would use the $10,000 withheld and purchase Apple stock at 15% less than the August 1st price of $145.52 (80 shares of AAPL. Note: Apple does not allow the purchase of fractional shares in their ESPP). 

If you sell immediately, at the market value on January 31st ($174.78), you gross roughly $14,000. You’ve immediately gained almost $4,000, which will be taxed at whatever your ordinary income tax rate is. For the sake of simplicity, I’ll assume you’re in the 35% tax bracket, so you’ve netted a little more than $2,500. Not bad!

Money withheld from your paycheck$10,000
Share price on August 1, 2021$145.52
Share price on January 31, 2022$174.78
# of shares purchased on January 3180
Sales proceeds (80 shares x $174.78)$13,982
Gain$3,982
Estimated tax @ 35%$1,394
Net proceeds$2,588

What if the stock price had actually gone down from August to February? 

You would still get a discount on the lower stock value, but it would be worth less when you sell and you would only gain the 15% discount. Let’s imagine the stock prices were reversed- $174.78 on August 1st and $145.52 on January 31st. You would still receive 80 shares of AAPL stock, but you would only be able to sell it for about $11,600. Again paying 35% tax on the gain, you would net about $750. Still better than nothing but quite a bit less than the first example.

Money withheld from your paycheck$10,000
Share price on August 1, 2021$174.78
Share price on February 28, 2022$145.52
# of shares purchased on March 180
Sales proceeds (80 shares x $145.52)$11,642
Gain$1,164
Estimated tax @ 35%$407
Net proceeds$757

In a market where your company stock is trending down, the maximum gain you would realize over a 6-month period is $12,500 (50% of the annual IRS limit) less $10,625 (50% of the maximum annual contribution, assuming a 15% discount) or $1,875- and that’s before you pay taxes.

Tax Implications: Selling the shares immediately

In the above examples, I assume you sell the shares as soon as you’re able (which is very close to immediately after the end of the offering period). This is considered a non-qualifying disposition, and you’re required to pay ordinary income tax rates on whatever the discount amount is. 

Tax Implications: Holding onto to the stock for more than a year

If you hold the stock for a full year from the purchase date, and 2 years from the beginning of the offering period in which you purchased shares, then the stock would be eligible for a qualifying disposition. In this instance, any gain would be taxed at long term capital gains rates, which are more favorable than ordinary income tax rates. Many people are enticed by the possibility of paying lower taxes, but holding the stock for longer is risky, and you might have no gain at all, or even a loss.

There is very little risk involved in participating in an ESPP if you sell the stock right away. If you hold the stock, your risk increases significantly.

Factors to consider

One of the most relevant issues here is- can you afford to have that reduction in every paycheck for the 6 month period before reaping the benefits at the end? For some folks, this is a fantastic way to automate savings. It enforces a certain behavior and then at the end of 6 months you can sell your company stock and invest how you see fit. In other cases, you just can’t afford to take a reduced salary. Given the limited benefit when the stock is trending downward, if the regular paycheck deductions present a challenge, I would likely not participate in the ESPP.

The other consideration is having too much exposure to your company stock. If you’re already receiving Restricted Stock Units or stock options, you may have a large portion of your portfolio in one stock. Add to this the fact that your salary and benefits are tied to this same company, it can get pretty risky.

How should I decide?

To recap, some pros of participating:

  • Enforced savings
  • Free money! Admittedly, LESS free money when the stock price is on a downward trend.

And cons:

  • Concentration risk
  • Increased tax complexity
  • Reduced cash flow
  • Potential volatility if you hold the stock
  • The manual process of selling and then reinvesting into some other vehicle (or as I like to call it, the “hassle factor”).

I have a bit of a love-hate relationship with ESPPs, but they are often worth doing, even in a down market. The potential benefit is quite small, but if you can afford to participate, it might be a good idea regardless of the way the stock is trending.

Incentive Stock Options, AMT and Qualifying Dispositions- Oh My!

If you have incentive stock options (ISOs) from your employer, you’ve likely considered when to exercise your options, and whether that will trigger the dreaded AMT. 

What are Incentive stock options (ISOs)?

Incentive stock options or ISOs are a type of stock option. A stock option is essentially the right to buy your company’s stock at a set price. They are commonly granted to employees as a part of their compensation package, especially in the tech industry. 

Here’s an example:

Your company grants you 10,000 ISOs with a strike price of $1.00 per share. The current Fair Market Value (FMV) of the company stock is $9.00. This means you have the option to buy up to 10,000 shares of your company stock at $1.00 per share, which is actually worth $9.00 per share. What a bargain! Why wouldn’t you do that? 

Incentive Stock Options (ISOs) at a public company

If, in fact, your company is publicly traded (i.e. anyone can buy the company stock), then you can turn right around and sell this stock for the $9 fair market value. You will be taxed on what is called the bargain element, which is the difference between the strike price and the fair market value. Note: the bargain element is a preference item under the AMT calculation. More on that below.

Incentive Stock Options (ISOs) at a private company

However, if you work for a private company (your company stock is not traded on a public market, like the New York Stock Exchange, it’s more complicated. You can buy those options, but more than likely you will not be able to sell them. So why would you do this? If you expect the value of the stock to increase and especially if the company might go public in the future, you are taking advantage of potentially lower tax rates on the growth of that stock.

That said, this is a highly risky proposition with regards to private company stock. If the company does NOT go public, you may have paid money to exercise stock which is ultimately worthless. 

What about taxes? And what is this dreaded AMT?

The trickiest part of working with ISOs is the tax implications. In particular, when you exercise ISOs, that triggers something called AMT or alternative minimum tax. AMT has been known to cause absolute panic in otherwise level-headed people. It’s not really all that scary, but many have been instructed to avoid “triggering” AMT at all costs. 

As referenced above, when you exercise ISOs, there is no tax due under the normal tax structure, but you will be taxed on the bargain element under the AMT structure. This only impacts you if you exercise ISOs in one tax year but do not sell them in that year. If you exercise and sell in the same calendar year, there is NO AMT. Instead you will pay ordinary income tax on the bargain element. Clear as mud, right? The scenario where you exercise and sell in the same calendar year is considered a disqualifying disposition. It’s not the most advantageous from a tax perspective, but it’s very straightforward.

What is a qualifying disposition?

A qualifying disposition occurs when you sell your stock at least 2 years after it was granted and at least 1 year after it was exercised. If these two criteria have been met, then you will be taxed on any gain at the long term capital gains rate (typically 15% or 20%, depending on your income). You still owe AMT on the bargain element in this case, in the year of exercise.

Many people have strong feelings about holding stock options long enough to have a qualifying disposition. While this is definitely better from a tax perspective, it may not be the best choice for you. By holding your company stock for a full year, you are opening yourself up to potential volatility.

How do you decide what to do?

In addition to tax considerations, as mentioned above, if your company is private, you must decide how much of your money (if any) you are willing to risk by exercising. How much can you afford to lose? This is a complex question and must be considered in conjunction with your larger financial picture in mind.

Additional considerations include:

  • Where will you get the money used to exercise options?
  • How will you pay the AMT tax bill when you file your taxes?
  • What is the general outlook of the company? Are you confident in its long-term prospects?
  • There are additional concepts around leverage and dilution that may be relevant.
    • Leverage refers to the difference between an option with a strike price of $1 (and FMV of $9) as compared to an option with a strike price of $8.50 (and FMV of $9). Which one would you rather have
    • And the percentage of ownership that your shares represent can have an impact, especially as those shares are likely to be diluted if the company issues more shares to other parties.
  • Read your company’s stock plan agreement to look for things like “repurchase rights” and “early exercise” options. You’ll want to know as much as you can about both your rights and the company’s. 

The final word: ISOs ARE complicated and there are a lot of things to bear in mind. It is unfortunately easy to “make a mistake” and end up with a surprise tax bill. Consider working with a financial professional and/or a tax advisor to thoroughly understand the implications of any transaction. And do as much research as you possibly can to understand the restrictions in place from your company. Check out our Instagram Live for more conversation about ISOs.

How to Prepare for an IPO

You’ve been working for a startup for a while now, and there have always been rumors about the company going public, but now it’s actually happening! What the heck should you do about it? How should you prepare? What’s the big deal with IPOs anyway?

What is an IPO and why do people get so excited about them?

An IPO, or initial public offering, represents the first time a private company is listed on a stock exchange, which means anyone can buy stock in the company. When a company is private, the stock is typically only held by employees, founders, and private investors.

“There have been 5,744 IPOs between 2000 and 2021. The least was in 2009 with only 62. The full year 2020 was an all-time record with 480 IPOs, but 2021 beat that record with 1058 IPOs.” (stockanalysis.com). Not only that, but 49% of high profile IPOs in 2021 are currently trading below their list price on IPO day. 

People get very excited about IPOs as there’s often a lot of money to be made in the early days of trading. If you can purchase this new stock at a relatively low price and benefit from explosive growth, doing so around an IPO might be the most likely time for that to happen. The potential IPOs we’re looking forward to in 2022 include Stripe, Outreach and Qualia.

A company might go public for a variety of reasons, from raising capital to cashing out early investors or raising the profile of the brand. So how does all of this impact you?

How to prepare for an IPO

Know what type of stock you have prior to IPO day

Is it restricted stock or stock options? How is the vesting structured? It is critical that you have a basic understanding of what your situation is. Stock options (incentive or nonqualified) are treated very differently from a tax perspective, and restricted stock units are unique in their own right.

Once your company establishes a plan to go public, they will likely have a number of information sessions for employees. I highly recommend attending as many of these as possible. The sessions will help you get a good understanding of the type of equity you have and how the IPO is going to unfold. Keep an eye out for restrictions on selling stock, lockup periods, and so on. 

Get to know your trading platform

These platforms tend to struggle on IPO day with lots of employees using the site at the same time. Be prepared for hiccups, but also know how the platform works in advance so you are less impacted by any glitches.

Consider working with a professional

It should come as no surprise that I highly recommend working with a financial planner and/or CPA to help you navigate this process. The sooner you start, the better. They’ll help you explore things like: What is the potential money for? How will you use it? Do you “need” it for a house down payment or is it truly “extra”? What are the tax implications of the IPO and selling/exercising shares? Note: the taxes around an IPO can be incredibly complex. With some strategies, you may need to have funds available to exercise options or pay taxes before you are able to sell shares. It is very easy to make a mistake here and a professional who knows what to look out for is well worth it!

Devise a strategy for diversifying out of this stock

IPOs often result in a very significant portion of your net worth being tied up in a single stock. A financial advisor will help you devise a strategy for diversifying out of this stock; having so much of your net worth focused on one stock is a huge exposure, particularly when that stock happens to be especially volatile as a recently public company’s stock generally is.

Be comfortable with uncertainty

Things change all the time with potential IPOs. Until your company files their S1 (the official filing with the SEC), you probably won’t know when it’s happening or what it will look like. Even after an S1 has been filed, there are still a lot of unknowns, and there’s no guarantee the IPO will even happen. You may have heard about the failed WeWork IPO in 2019. They finally went public in 2021 at a valuation of 80% LESS than it was worth in 2019.

Get used to the idea that things will change. IPOs are volatile and unpredictable so the sooner you accept these facts, the better equipped you’ll be to handle them.

Plan for as much time “away” as possible; from co-workers, the company Slack channel, and so on

IPOs are incredibly exciting and emotional and you will absolutely need time to decompress. Breathe, drink water, “try” not to obsess. I suggest to my clients that they allow themselves a certain amount of time to check the stock price or read the latest updates on the stock. The rest of the time, turn off notifications and try to avoid looking at the activity throughout the day. Doing so is a sure way to increase your anxiety.

IPOs are a wild ride, to be sure, and can absolutely provide you with a life-changing amount of wealth. Buckle up, and good luck!

Introduction to Equity Compensation (aka Alphabet Soup)

If you’re new to the tech industry, the world of equity compensation might be unfamiliar with all the types of stock/stock options. It is, in fact, fairly complex and the terms and acronyms can seem like a ​​foreign language. To be honest, it often just takes time to get comfortable with the various concepts. In any case, I’d like to present an overview of the most common types of equity comp and how you can think about those.

I think it’s worth taking an even bigger step back and defining the word equity, as used in this context. Equity, at the most basic level, is a form of ownership. Stock is a type of equity and is used by many tech employers to make employment more compelling. When an employer grants equity to their employee, not only are they providing a better overall compensation package, they are typically hoping the employee will be more engaged and work harder as the individual stands to benefit from any increase in the value of the company.

Restricted Stock Units (RSUs)

If you work for a public tech company (and especially one of the FAANG companies) it’s very likely that you will be granted Restricted Stock Units (RSUs). RSUs are perhaps the easiest to deal with, both from a tax perspective and also from a decision-making point of view. As in, there are fewer decision points when it comes to RSUs. I wrote a more detailed explanation of them here.

With RSUs, your company will give you a grant of, say, 500 shares of their stock. But they don’t give them to you outright, they come with a vesting schedule.

It generally works something like this:

Beginning on 11/1/21, your shares will vest quarterly, 1/16 per quarter (or in this example ~31 shares per quarter). Or they might use something called cliff-vesting; the most common version being 4 year vesting with a 1-year cliff. In this example, 1/4 of the shares vest after 1 year and the rest vest as above, 1/16 per quarter for the remaining 3 years. In this case, that would be 125 vesting on 11/1/22 and then ~31 shares quarterly thereafter.

What exactly does vesting mean?

Essentially, it means the shares are now yours to do with as you choose. You can either sell them and use the cash for something else OR you may choose to hold on to them if you think the company’s future prospects are strong. It also means that the value of the shares on vest date is added to your taxable income for that year.

When you start a new job, you will typically be awarded an initial grant. In subsequent years, you may be offered a refresher grant, but the number of shares could be quite a bit less than the initial grant. This leads to a lot of “job hopping” as employees are not incentivized to stay after the initial grant has fully vested and their total comp declines.

There are multiple variations on how RSUs can work and the above examples are the most common. Recently I’ve seen companies shifting to an award that is based on dollar amount vs number of shares. Stripe recently shifted to this model (to the consternation of many employees) and now, instead of a specific number of shares vesting, you will be awarded a set dollar amount (say $5,000). Stripe will then calculate how many shares that is equivalent to on the date of vest. The downside with this structure is that there is less upside potential for the employee. If you hold the RSUs after they vest, they can always increase in value, but you have less opportunity to reap the benefits between grant and vest date.

Incentive Stock Options and Nonqualified Stock Options (ISOs and NSOs)

Another common type of equity compensation is stock options. Unlike RSUs, with stock options you’re not granted actual shares of stock, but rather the right to purchase stock at a certain price. Like RSUs, stock options are typically granted with a vesting schedule. There are two types of stock options- Incentive Stock Options (ISOs) and Nonqualified Stock Options (NSOs). The primary difference between the two types is in how they’re treated from a tax perspective. 

Stock options are far more complicated than RSUs. Along with the decision about when to sell, they have an added decision-making component- with stock options you have to decide if/when to exercise (aka buy) your options AND when to sell. With RSUs, your only decision is when to sell.

How Stock Options Work

Your company might issue you stock options at a certain exercise price (i.e. the price you pay for the stock). For example, you might be issued stock options with an exercise price of $5/share. If the current value of company stock is $15/share, you can imagine these options being attractive! You can buy a share for $5 and then turn around and sell it for $15. Not a bad deal. This is where it gets tricky- the difference between the exercise price and the fair market value (also known as the “bargain element”) is taxed. In this example, the bargain element is $15 – $5, or $10. And the amount of tax you pay depends on the type of stock option and how long you hold the stock once you buy it.

Exercising ISOs

When you exercise ISOs, you trigger something called Alternative Minimum Tax (aka AMT). The mere idea of triggering AMT causes many people to panic, but not many people fully understand how AMT works (and I’m not going to explain it in detail for this article). But if you exercise and sell in the same calendar year, you simply pay ordinary income tax on the bargain element. Easy right? Not exactly.

If you plan to exercise and/or sell stock options, it is HIGHLY recommended that you work with a CPA who has knowledge in this area. The tax implications are significant and it’s very easy to make a mistake.

ESPP, PSUs and other forms of equity comp

RSUs, ISOs and NSOs are far and away the most common types of equity comp. There are others, however, and the Employee Stock Purchase Plan (ESPP) is one that has become increasingly popular.

Employee Stock Purchase Plan (ESPP)

The basic idea with an ESPP is that your employer allows you to buy the company stock at a discount, which you can then sell for a profit. The company withholds an amount from each paycheck for 6 month periods. At the end of each period, they take all of the accumulated contributions from your paycheck and purchase the stock for you. They’ll use either the price on the first day of the 6-month period or at the end of the 6-month period, whichever is lowest, and the discount gets calculated off the lower price. I wrote a detailed example of how this works here.

Restricted Stock Awards (RSAs)

Yet another type of equity compensation is Restricted Stock Awards (RSAs), which are NOT the same as RSUs. RSAs are generally issued by very early stage private companies. The shares are issued at grant and held in escrow until they vest. RSAs are eligible for something called an 83(b) election which allows you to pay tax on the “gain” (usually 0 or very close to it) up front, thereby enabling you to pay future gains at your capital gains tax rate.

Performance Share Units (PSUs)

You might be granted something called Performance Share Units (PSUs) which function much like RSUs but are tied to performance, not a traditional vesting schedule. The tax treatment of PSUs is the same as RSUs; in other words, the value of the shares on the date of vest is part of your taxable income.

Final thoughts

If you’re lucky enough to be granted some form of equity compensation, you’re likely recognizing some benefit from the value of your company’s stock. I’ve worked with clients who had 4 different types of equity compensation from their employer which gets incredibly complex. There are a host of considerations; from taxes to if/when to exercise and sell and what the proceeds will be used for. It’s incredibly useful to work with both a financial planner and a CPA who have expertise in this area.

The real fun begins when we start to discuss what opportunities you have available to you if your equity compensation ends up significantly changing your financial situation, as it very often does. 

Should I participate in my company’s Employee Stock Purchase Plan?

If you work at a large, tech company, there’s a good chance they offer an Employee Stock Purchase Plan (ESPP) as one of the company benefits. The question is, should you actually participate and if so, how do you manage it?

I’ll be honest, I have a love-hate relationship with ESPPs. Sure, they are a great benefit and they are essentially “free money”. But darn if they aren’t complicated and they do require some active management. There are plenty of cases where I do not recommend participating, despite the fact that some people think participating is a “no-brainer”.

How does it work?

First of all, I want to explain how they work and what the actual benefit is. Essentially, you can buy your company’s stock at a discount, and then turn around and sell it for the actual market value. The difference is yours to keep (less taxes due). But how it’s actually structured is a bit more complicated. 

Let’s use the Salesforce plan as an example. Suppose your salary + bonus is $150,000. You can contribute between 2% and 15% of that income – Salesforce caps ESPP contributions at $21,250 (or $25,000 stock at Fair Market Value, less 15% discount). Each pay period, Salesforce will withhold that percentage which you elect and hold it until the end of the “offering period”. For most companies, the offering period is 6 months and Salesforce has their 2 offering dates as June 15 and December 15. On these two dates, they use the total amount withheld over the prior 6 months, and purchase shares for you, which are then transferred to an account in your name.

The amount you pay for the shares is the lower of two prices—the date at the beginning of the offering period or the purchase date price—plus an additional 15% discount.

In this example, if you had withheld the maximum amount, $10,625 between June and December 2020, the lower price would be that on June 15, 2020. On December 15, Salesforce would use the $10,625 withheld and purchase CRM stock at 15% less than the June 15th price of $178.61 (70 shares of CRM). If you sell immediately, at the market value on 12/15 ($220.15), you gross roughly $15,400. You’ve immediately gained over $4,700, which will be taxed at whatever your ordinary income tax rate is. For the sake of simplicity, I’ll assume you’re in the 32% tax bracket, so you’ve netted about $3,200. Not bad!

 

Money withheld from your paycheck $10,625
Share price on June 15 $178.61
Share price on December 15 $220.15
# of shares purchased on December 15 70
Sales proceeds (70 x $220.15) $15,407
Gain $4,782
Estimated tax @ 32% $1,530
Net proceeds $3,252

What if the stock price had actually gone down from June to December? You would still get a discount on the lower stock value, but it would be worth less and you would only gain the 15% discount. Let’s imagine the stock prices were reversed- $220.15 on June 15 and $178.61 on December 15th. You would still receive 70 shares of CRM stock, but you would only be able to sell it for about $12,500. Again paying 32% tax on the gain, you would net about $1,300. Still better than nothing but quite a bit less than the first example.

 

Money withheld from your paycheck $10,625
Share price on June 15 $220.15
Share price on December 15 $178.61
# of shares purchased on December 15 70
Sales proceeds (70 x $178.61) $12,500
Gain $1,875
Estimated tax @ 32% $600
Net proceeds $1,275

But does it make sense?

One REALLY big factor here is- can you afford to have that reduction in every pay check for the 6 month period before reaping the benefits at the end? For some folks this is a fantastic way to automate savings. It enforces a certain behavior and then at the end of 6 months you can sell your company stock and invest how you see fit. In other cases, you just can’t afford to take a reduced salary. 

The other huge downside is having too much exposure to your company stock. If you’re already receiving Restricted Stock Units or stock options, you are starting to face a potentially large portion of your portfolio in one stock. Add to this the fact that your salary and benefits are tied to this same company, it can get pretty risky.

One of the tricks to successfully taking advantage of an ESPP is to manage the risk as much as possible, which often means selling the stock as soon as you’re able. There are also, as you might be wondering, some tax considerations to think about.

In the above examples, I assume you sell the shares as soon as you’re able (which is very close to immediately after the end of the offering period). This is considered a non-qualifying disposition, and you’re required to pay ordinary income tax rates on whatever the discount amount is. 

If you hold the shares for a full year, and two years after the plan becomes available to you, you now have a qualifying disposition. In a qualifying disposition, you still pay ordinary income tax rates on the discount amount, but you only pay long-term capital gains tax rates on the growth, if any. Your long-term capital gains rate could be as low as 0% (highly unlikely if you work in tech!) or it could be 20%, but is almost certainly lower than your ordinary income tax rate.

The huge downside to holding the shares in order to receive this preferential tax treatment is- you guessed it- again, too much exposure to company stock. There is always risk withholding any one stock due to increased volatility and in this case, having too many of your eggs in one basket. I almost never recommend that clients hold shares long enough to be a qualifying disposition.

Taxes on ESPP get very complicated and the above examples are a huge oversimplification. If you plan to participate in your ESPP, you’ll definitely want to run it past your tax preparer.

So should I participate or not?

To recap, some pros of participating:

  • Enforced savings
  • Free money! (Who doesn’t like free money??)

And cons:

  • Concentration risk
  • Increased tax complexity
  • Reduced cash flow
  • Potential volatility if you hold the stock
  • The manual process of selling and then reinvesting into some other vehicle (or as I like to call it, the “hassle factor”).

Like I said, I do not consider participation to be a no-brainer and there are definite downsides to be aware of. But ESPPs can be a fantastic benefit if you manage them properly. Consider working with a financial planner to decide if it’s the right option for you.

 

Where do I even start with my RSUs?

One of the most common issues facing my clients is how to manage their equity compensation, specifically restricted stock units (or RSUs). If you work in the tech industry, there’s a good chance that you receive RSUs as a part of your total compensation package. They can be a huge upside for you, if they are managed well, but they can also be very risky.

What the heck are RSUs?

Let’s start with what RSUs are and how they typically work. For the sake of this article, I’ll be referring to RSUs in a publicly traded company (think Amazon, Facebook or Salesforce). Essentially, your company has awarded you some kind of bonus but you don’t actually get it right away. Bummer. A cash bonus is pretty easy to understand, right? A “bonus” in the form of RSUs just takes a little longer to receive. You have to wait for the shares to vest. If your employer grants you 100 shares of Amazon stock, vesting over 4 years, you don’t have to do anything at all today. You will receive 25 shares of Amazon stock that vest each year for the next 4 years.

In other words, based on the vesting schedule, your RSUs will come to you over a period of time. You don’t have to do anything to get them. In that regard RSUs are a lot more straightforward than stock options. The only decision you really have to make is when to sell them.

An example of how RSUs work:

As mentioned above, your company grants you 100 RSUs vesting annually over 4 years (many companies actually have shares that vest monthly or quarterly, but for the sake of simplicity, let’s assume they vest annually only).

1/1/2020: company grants you 100 shares

1/1/2021: the first 25 shares vest

1/1/2022: another 25 shares vest

1/1/2023: another 25 shares vest

1/1/2024: the final 25 shares vest

TAXES

When your shares vest, your company will sell a portion of what vests to cover the taxes. In many ways, this is great! They sell some for taxes, pay the IRS, and the rest is yours. Instead of 25 shares, you might receive 19 after taxes. The challenge is that most companies sell only the statutory minimum of 22%. A lot of people get burned by this when tax time comes around. Imagine you’re in the 35% tax bracket but your company only withheld 22% for taxes. You’re going to owe the IRS a chunk of change, which you may not have handy (unless you sell some of your shares). If you have done some tax planning, and you’re prepared for this tax hit, you’ll be fine. But there are plenty of folks who are caught by surprise in this situation. 

Another factor regarding the taxes, is what happens when you decide to sell your remaining vested shares. When you sell your vested shares, you will owe taxes again (either short-term or long-term capital gains) on the growth from the value at vesting to value when you sell. Many people think there’s a long-term tax benefit to holding the shares for 12+ months after they vest. I can almost guarantee one of your co-workers has suggested this to you. However, if you sell your RSUs as soon as they vest, there will be virtually no gain (i.e. growth) from the value at vest. In fact, the longer you hold your RSUs, the riskier they become as the share price is not guaranteed to go up (try telling that to a long-time Amazon employee!).

Why are RSUs risky and how should you think about them?

The reason why holding RSUs is risky, is that your company’s stock price is not guaranteed. It could certainly go up, but it can just as easily go down. If you have a large percentage of your net worth tied up in your company stock, not to mention having your salary + benefits tied to your employer, this could be pretty nerve-wracking. 

One of my favorite ways to frame this for clients is this: “If your employer gave you a cash bonus (instead of RSUs), would you invest it in your company stock?” I have yet to meet someone that says yes. It’s very easy to get caught up in emotions with RSUs, but I find this way of looking at them to be very useful. In many cases, it makes sense to sell them and do something else with the proceeds (invest in a more diverse set of funds, use towards other short/long-term goals), but there is no one-size fits all advice here. I recommend you talk with a financial planner who understands RSUs and ideally also work with a tax preparer who is proficient in this capacity. Together with these professionals, you can devise a strategy for managing your RSUs.