Understanding Restricted Stock Units (RSUs): A Guide for Our Clients

Understanding Restricted Stock Units (RSUs): A Guide for Our Clients

January 19, 2024

Understanding restricted stock units - RSUs

Understanding Restricted Stock Units (RSUs): A Guide for Our Clients

January 19, 2024

Executive compensation is a broad term used to encompass the many ways our clients are compensated throughout their careers (and after). Decisions made today are about optimizing current year income & tax and lowering your lifetime tax bill to meet your goals. As a trusted partner, we provide clarity around those decisions so our clients can feel confident in their financial lives.

This overview dives into an increasingly important topic in executive compensation: Restricted Stock Units (RSUs). Whether you're already familiar with RSUs or just starting to explore them, this guide aims to demystify this aspect of your compensation package.

What Are RSUs? 

At its core, a Restricted Stock Unit (RSU) is a promise from your employer to grant you a certain number of company shares at a future date, usually subject to meeting certain conditions. Unlike traditional stock options, which grant the right to purchase shares at a specific price, RSUs provide you with actual shares after a vesting period.


Vesting: The Key Milestone

RSUs are typically subject to a time-based vesting schedule, which dictates the timeframe over which you gain ownership of the granted units. Vesting schedules are often designed to encourage your long-term commitment to the company. Once RSUs vest, the shares are converted into regular company stock, and you become a shareholder. Companies can add other vesting triggers, such as an IPO or change in control, often referred to as a "Double Trigger" vesting schedule.


Why RSUs Matter: The Benefits

  • Alignment of Interests: RSUs tie your financial success to the company's performance, fostering a sense of alignment between your interests and those of the organization.
  • Long-Term Focus: The vesting schedule encourages you to stay with the company over the long haul, potentially leading to increased loyalty and stability.
  • Potential for Gains: If the company's stock value rises, your RSUs can become more valuable over time. 

Risks and Considerations

  • Market Volatility: Fluctuations in stock prices can impact the value of your RSUs, so it's essential to plan conservatively for future vest dates if planning to use the funds for a short-term goal.
  • Diversification: Relying heavily on RSUs can lead to an imbalanced investment portfolio, which may not be ideal for managing risk. A "vest & sell" strategy is often the prudent choice to diversify your net worth from your paycheck.
  • Tax Implications: RSUs are subject to taxation upon vesting, affecting your overall take-home value. Your company will automatically withhold shares for tax (22% Federal minimum), which may not be enough if your effective tax rate exceeds that amount. Planning early with your advisor, accountant, and HR team can minimize this shortfall.

Taxation and Financial Planning

  • Tax Timing: RSUs are taxed as ordinary income when they vest. Regardless of your post-vest strategy (sell/hold), you owe ordinary income on the value of the shares at the vesting date. This value establishes your cost basis for capital gains tax purposes (discussed below). It is a key difference from stock options, where you may have flexibility on the timing and type of tax.
  • Planning Ahead: Your company may have a blackout period or specific trade windows following your vest date where you can sell your vested shares. It is important to pay attention to these dates as you may need to liquidate shares soon after vesting to cover your tax liability if you don't have liquidity elsewhere. This is particularly important in Q4 vesting dates, with estimated tax and April 15th tax payments due shortly after.
  • Capital Gains Tax After RSU Vesting: After RSUs vest and are delivered to your account, the clock begins for your investment holding period for capital gains tax purposes. Any gain above the value at vest is subject to capital gains tax (or loss). If you sell <1 year from vest, the gain or loss will be booked as short-term. If you hold past one year from vest, any gains or losses will be given long-term tax treatment. 

Incorporating RSUs into Your Financial Plan

  • Goal Planning & Time Horizon: Whether covering a big tax bill or needing liquidity to cover a major purchase, automatic reinvestment may not be in your best interest. Aligning your goals and cash flows is an often overlooked step in RSU planning.
  • Diversification: If reinvestment makes sense, we'll work with you to ensure your investment portfolio is diversified, reducing the potential impact of any single stock's performance.
  • Tax Efficiency: Our goal is to help you understand and manage your tax liability effectively, considering the specific taxation rules associated with RSUs. 

Your Partner in Navigating RSUs

As a trusted advisor, our role is to guide you through the intricacies of RSUs. We're here to:

  • Educate you about RSUs and their role in your financial journey.
  • Develop a tailored financial plan that optimizes your RSUs within the broader context of your goals.
  • Provide ongoing support as your circumstances change and new opportunities arise.

Conclusion

RSUs can be a valuable part of your executive compensation package, but they also come with complexities that require careful consideration. By working together, we can help you maximize your RSUs while safeguarding your overall financial well-being. Feel free to reach out to us with any questions or concerns – we're here to help you navigate the path to financial clarity for life.

 

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This article is not intended to provide tax, legal, accounting, financial, or professional advice. Readers should seek advice from qualified professionals who can review their specific circumstances. Old Peak Finance endeavors to provide information that is accurate and current. However, we cannot guarantee that this information has not been outdated or otherwise rendered incorrect by new research, legislation, or other changes. Old Peak Finance has no liability or responsibility to any individual or entity with respect to losses or damages caused or alleged to be caused, directly or indirectly, by the information contained on this website.

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