Become a better investor
Restricted Stock Units, or RSUs, are one of the most common forms of equity compensation for tech professionals. I use an example to explain how RSUs work and a couple of things to think about when deciding what to do with them.
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So first, just doing a quick breakdown of the actual term restricted stock units. First, from the restricted perspective, it's restricted because they have strings attached to them. So that means that whenever you get it then there are actually things that you have to do before they become yours. That's usually tied to a vesting schedule that could either be an amount of time to keep working at the job, it could be performance-based, or it could be a combination of both.
Then the other part of it, the fact that it's a "stock unit," means that it is tied to stock in your company, but it's not actual stock yet. It's just a promise that they are going to give you the stock at a future date as soon as you satisfy the restrictions.
Let's do this through an example. Let's say that you've just started a new job and you're working for ABC Company. Then ABC Company has said, "Hey, as a bonus for you coming on, then we are going to grant you 8,000 RSUs in the company." Then in this example, let's say that the restriction is that it's going to be on a four-year graded vesting schedule.
All this part is saying is that in order to get the 8,000 RSUs and turn them into shares of stock then you have to stick around for four years. The fact that it's graded means that you get a certain amount every year. So if you stick around one year then you'll get 2,000 and then another year you'll get another 2,000 until you're there for four years.
The second big question to answer is, "what should you do now with the rest of the shares that you have?" The way that I like to pose this question to clients of whether to sell or not is to imagine the scenario of instead of your company doing the stock bonus that they actually gave you $13,000 as a cash bonus.
Then the question is, would you then take that $13,000, go to your brokerage account, and buy shares of stock in your company. If the answer to that is "No," then that's just another way of saying to go ahead and sell the rest of them right here. If you sell them the date that they vest, then there are no additional taxes due to it because we've already figured out this bonus income tax. Once it invests here, then any taxes afterward is just the same as if you bought it and you had to think about capital gains and capital losses.
Another thing to think about is this idea of "Concentration Risk." That's just a way of saying that you have part of your net worth tied to your company in the form of stock, and then also your paycheck is tied to that company because you're also working for them. So if you want to diversify away from that, then the idea would be to sell the shares of your stock and put that into other investments. You'd still want your stock price to go up because, remember in our example, 2,000 shares have vested, but there's still 6,000 left that are going to vest in the next three years.
First, whenever you think about the grant date - 8,000 RSUs granted to you, and then at that time then the company is going to have a certain stock price. But the thing is this the price whenever it's granted doesn't matter because they're just RSUs, and since nothing has vested, then there's really nothing for you to do here, really. The only thing that matters is just seeing the potential of what these things could be valued at as you go along.
So in our scenario, if you've stuck around for a year, then 1/4 of your shares are going to vest on this date, and so you're going to get 2,000 shares of stock on this date. Then this is where it really does matter what the price of the stock is on that vesting date. If you have 2,000 shares that vested here and then it's at ten dollars a share, then from a tax perspective, then what just happened is that you just got a $20,000 bonus.
Just like a cash bonus, what that means is that this $20,000 is subject to federal taxes, state taxes, medicare, and social security. Then also, just like with your paycheck then that means that taxes will need to be withheld from this dollar amount.
A very common way that the company will withhold those taxes for you is that they'll take a portion of these shares, and they'll surrender them and sell them in order to withhold the taxes from them. So, for example, in our scenario, if there are 2,000 shares that vested, then they would withhold 500 of those shares to pay for the taxes.
Then the end result of all of that is that you now become the proud owner of 1,500 shares of stock in your company.
Then there are two main questions that you need to answer, and the first one is "do you need to withhold any more taxes?" So what we're really talking about is your company has withheld a certain amount, but it's very common for your for the company to just withhold a standard 22 percent from a federal tax rate.
So if, for example, you're at the 32 percent tax bracket, there's actually another $2,000 that you should withhold in order to pay taxes on this $20,000 bonus. Okay, so what we did in order to withhold more taxes, to hold another $2,000 is that we sold 200 shares and so now we're left with 1300 shares.