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
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.