How Do RSUs Work, and How Can They Fit Into Your Savings Plan?
RSUs are a benefit a company may offer to its employees as a way to give them extra compensation. Find out how RSUs work.
Contributing Writer at Tally
June 10, 2022
This article is provided for informational purposes only and is not to be construed as legal or investment advice. Consult with a professional financial or investment advisor before making investment decisions.
Employer compensation plans can include a wide range of ways to reward their employees. Employee stock options (ESOs) have long been a sought-after form of compensation, since employees can earn additional money by buying company stock at special prices.
A similar kind of compensation, known as restricted stock units (RSUs), has grown in popularity recently. Like ESOs, RSUs give employees stock in the company they work for, but also have other features designed to keep employees more engaged with the company overall.
So you may be wondering, “How do RSUs work?” We’ll take a deep dive into this type of equity compensation, including how often you can expect to receive RSUs, their typical vesting schedule and how you can work them into your existing financial planning and investment plans.
What are RSUs?
Restricted stock units (RSUs) are a form of employee compensation designed to attract you to a company and keep you engaged with that company for years to come. Employees receive this form of compensation via a distribution and vesting schedule that works on a time or milestone basis.
You could receive these shares of company stock and become vested in them by completing a specific task (milestone), like launching a company website, or by simply staying with the company for a specific amount of time, like after completing your first year on the job.
RSUs have no value when they are first issued to you. Instead, they gain value only after you meet the RSU vesting date or milestone. Once the vesting schedule is met, the RSUs receive a fair market value (FMV), and that FMV is used to calculate the income tax that you’ll pay on the now-vested RSU.
After vesting, you are free to sell and trade the RSUs as you see fit.
When will I receive my RSUs?
Every employer distributes RSUs in different ways. Some will give you your initial RSUs upon signing your employment contract, then give you any additional RSUs on a quarterly or yearly basis, depending on the contract.
Other companies may make you wait a specific number of months or years before reaching your RSUgrant date. As mentioned, they may also tie them to specific milestones, such as the company raising a predetermined amount of capital or your role in the launch of the company website.
Even though you may have received your RSUs, this is still not a tangible asset with any liquidity. The vesting schedule determines when the RSUs earn their value.
When will my RSUs vest?
This depends on your employment contract. Some give 100% vesting of the RSUs after reaching a specific milestone, whereas others slowly award them over a longer period of time.
Commonly, employers use a four-year vesting schedule with a one-year cliff. This means that, one year after receiving your RSUs, 25% of your RSUs will vest. After that first year, the remaining RSUs will vest on a fixed schedule that may be monthly, quarterly, semiannually or annually.
A common four-year vesting schedule is 1/36 vesting each month after the initial 25% one-year cliff. So, for each month in the remaining four years, you will vest in 1/36 of the RSUs you received. This means in three more years — making for a total of four years — you will have 100% vesting.
Can I sell my RSUs?
One big benefit of RSUs is the fact that you can sell them as you please — though only after they’re vested. So, if you earned 1,000 RSUs with a four-yearvesting schedule and a one-year 25% vesting cliff when you were first hired, you could sell up to 250 shares after one year.
You can sell your RSU shares as they vest. There’s no need to wait for them all to vest before selling. So, when you hit your one-year cliff, you can sell those shares, then sell the others according to the ongoing vesting schedule.
Selling your RSUs is similar to selling any other stocks on the stock market. You can simply sell them via the brokerage account your company uses to distribute them.
Are my RSUs taxable income?
When you receive the initial RSU payout, it will not be considered taxable because the RSUs carry no value until you are vested.
However, as RSUs vest, they become taxable income. Once the RSUs vest, the employee must subtract the initial purchase or exercise price from the fair market value of the stock. The remaining balance must be taxed as ordinary income in the tax year that the RSU is vested. Keep in mind that the initial purchase or exercise price may be zero if the stock was awarded instead of purchased.
If the employee retains the stock at vesting but chooses to sell it later, there are even more tax implications. The IRS considers the difference between the per-share price you sold stocks at and the fair market value at the time of vesting as capital gains or losses — and taxes it as such.
How do RSUs work in your current investment strategy?
RSUs can be a part of your investment strategy, but in a slightly unorthodox way.
Instead of sitting on your RSUs and letting them grow after satisfying the vesting period, some financial advisors recommend selling them the moment any number of shares vest. Then, you can use the proceeds to fund investments with tax benefits, i.e. an individual retirement account (IRA).
Why sell your vested shares? The key reason is there is no tax incentive to keep them. Much like a stock option, RSUs get long-term capital gains tax treatment as they grow. However, if you sell them and invest the proceeds into a Roth IRA, you won’t pay taxes on any growth.
This is not a hard-and-fast rule, though. A good test to determine whether to sell your RSUs or keep them is to decide whether or not you would invest a cash bonus in company stock via a brokerage. If you’re confident enough in your company’s performance to make such an investment, you may consider keeping some or all of your RSUs.
As with any investment strategy, it’s smart to speak with a financial advisor or Certified Financial Planner (CFP) to review your current investments and financial goals. They’ll review the value of the shares and the potential tax consequences relative to potential growth and advise you of the available options going forward with your RSUs.
RSUs can be a useful tool in your investment strategy
Now that we’ve explained how RSUs work, you can better grasp how they fit into your existing investment strategy. In most cases, it’s more beneficial to immediately sell any vested RSUs, as they have no tax benefits. However, if your company is one you would feel comfortable investing in on the open market, it may be worthwhile to keep them.
To better determine your next steps, speak with a financial advisor and go over your investment strategy and goals. They can help you decide if it’s in your favor to sell all of your RSUs, keep some of them or keep them all.
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