Along with a salary and benefits, some jobs also offer stock options or stock itself. This gives you an opportunity to profit off your own hard work as the company grows. Restricted stock units are a type of compensation where you eventually receive stock, but with limitations on when you receive it and when you can sell it.
If your job offers restricted stock units, it may take a little education to understand the value of what you’re offered.
What Are Restricted Stock Units?
Restricted stock units, or RSUs, are a method your employer can use to grant you shares of company stock. Generally, you receive shares on a vesting schedule. For instance, if you are offered 1000 RSUs, vested in two years, you will receive 1000 shares of company stock two years from now.
Until the shares are vested, they aren’t worth much. You won’t receive dividends, and you don’t have voting rights. Some companies, however, offer dividend equivalent payments before your shares are vested. This money is taxed like regular income.
Your vesting schedule may be either a “cliff” schedule, a “graded” schedule, or a combination of the two. In a cliff schedule, you receive all your shares at once, at some future date. That can be when the company goes public, if it isn’t yet, or after a certain number of years at the company. In a graded schedule, you will receive a certain percentage at each of specified dates. Vesting can also be set based on your or the company’s performance.
If you leave the company before shares are vested, you won’t receive any of the stock. This incentivizes you to stick with the company for the long haul.
How Are RSUs Taxed?
Normally, purchasing stock isn’t taxed, only selling it. But since you receive stock as part of your compensation, vesting creates a taxable event. When you receive your shares, the company will withhold taxes based on the shares’ fair market value at the time. There are several different ways to do this. The company may offer you a choice, or have a single way they always withhold taxes on restricted stock units.
One popular way is for the company to pay the tax for you, in exchange for an equivalent percentage of your stock. That way, the stock doesn’t have to be sold to pay taxes.
Of course, when you sell the stock, you may be liable for capital gains tax. You will pay tax on the profit, meaning the change in value between when you received it and when you sell it.
Pros and Cons of Restricted Stock Units
The most common alternative to RSUs is stock options. Like RSUs, stock options involve receiving nothing now, and eventually owning stock in the future. But stock options only give you the option to buy shares—you don’t receive them for free like RSUs. Stock options give you the right to buy shares at an agreed-upon price. If the fair market value of the shares drops below your stock option price, you don’t receive anything of value. Restricted stock units, on the other hand, always have value because you will receive the shares for free.
In the negatives column, however, you do have to pay taxes on RSUs when you receive the shares. If you’re not ready to sell yet, you wind up paying taxes even though you don’t take home any extra money.
Another downside is that you lose the shares if you leave the company before they’re vested. That’s an advantage for your employer, because it allows them to reward employees for sticking around. But, since you can’t always predict why you might need to leave the company, it means you can’t rely on receiving the shares until they actually vest.
Get Solid Advice on Your Investments
Receiving restricted stock units puts you in a position of managing individual stocks, which you might not have otherwise planned to do. Whenever you invest like this, it’s wise to get sound advice from an outside source. Your employer will always prefer it if you keep your stock, but is that in your best interest? How can you best offset the hit to your taxes when your RSUs vest?For answers to these and other questions, you need a financial advisor. Contact us today to be matched with the right advisor for you.