Stock Options Made Simple: What Do You Need To Know About RSUs?

Equity compensation is an incredible wealth-building opportunity, but it also comes with significant responsibilities. Our first article delved into the intricacies of incentive stock options (ISOs). Today, we’ll focus on a different yet increasingly popular equity tool: restricted stock units (RSUs). RSUs are a promise of stock that you receive once you meet set vesting or performance metrics. While the definition may seem simple, the job of creating a coordinated strategy around them requires a bit more creativity and finesse. How can you make the most of your RSUs?

The Basics Of Restricted Stock Units (RSUs) + Key Terms

With RSUs, your employer commits to giving you company stock once you or the company meet specific requirements. In most cases, the conditions fall into one of two buckets: 

1. Performance measurements, or 

2. Time at the company.

After you check the boxes, you receive the shares of stock. This feature is a fundamental difference from ISOs (and other stock options), where you have the right to buy the stock. With RSUs, you’re actually given the stock, opening up various planning opportunities. RSUs come with several key terms and dates. Having a deep understanding of how these units function empowers you to make intentional decisions:

• Grant Date: The date your company promises “restricted” shares of stock.

• Vesting Schedule: The “schedule” outlined by your employer detailing when your shares vest and are distributed. Most vesting schedules are either on a “graded schedule” or a “cliff schedule''. With a graded vesting schedule, you receive incremental grants of the RSUs over time. With a cliff vesting schedule, you receive a lump-sum tranche of your RSUs at a specified date.

• Vest Date: When your shares are no longer “restricted,” and you own them.

Benefits Of RSUs

RSUs are one of the more straightforward forms of equity compensation and, as such, come with unique benefits. First, RSUs don’t require you to purchase your shares (a welcomed contrast to ISOs).  While RSUs often have strict vesting and distribution schedules, not having to “pay for your grants” certainly comes in handy from an immediate cash flow perspective. Second, you don’t have to worry about additional taxable income once the shares are granted. However, you will have to wait until your shares vest to collect dividends and exercise voting rights (if applicable). Third, RSUs are taxed after the vesting period is completed. So, RSUs don’t immediately impact your tax burden, which is a helpful detail in proactive tax planning scenarios. Finally, RSUs are often less risky. The main reason is that you don’t have to spend any money to obtain the stock. 

How Are RSUs Taxed?

While RSUs are more straightforward than other forms of equity compensation, they aren’t a walk in the park. However, getting a solid grasp of their tax implications is a perfect first step.RSUs have two taxable events:

1. When your RSUs vest: When your RSUs vest, they will be taxed as ordinary income—like a cash bonus. A portion of your shares will be withheld to pay taxes, but you should double-check that enough is withheld since your employer is only required to withhold 22% (according to flat IRS limits). Honing in on this critical detail means you can more appropriately align your RSU withholdings with your W-4 withholdings established for base pay (or traditional compensation).

2. When you sell your shares: When you sell your shares, you’ll either incur short-term or long-term capital gains tax, depending on how long you hold the shares. If you hold them for more than one year, the gains will be taxed at a more favorable long-term rate. It is often beneficial to sell enough of your RSUs to cover the cost of your tax bill.

Four Simple Ways To Maximize Your RSUs

If you’re offered RSUs, here are four ways to make sure you’re getting the most out of them:

• Remain with your company until the shares have vested. This should be a no-brainer, but leaving before they vest would simply leave “money on the table.”

• As with ISOs and other stock options, know your financial goals. Ask yourself how your RSUs can help you reach a specific goal. Maybe you’re looking to bolster your retirement funds, start a home remodel, or save for your kid’s education. For those who are charitably inclined, how can your RSUs allow you to give more and also receive some tax offsets?

• Be extremely mindful and proactive in understanding where you are in your tax bracket. You want to make sure that the income from your RSUs doesn’t push you into the next tax bracket (if you can avoid it).

  • Bonus: When it comes to strategic and proactive tax planning, include any vesting RSUs into your tax projection for the year. In addition, be cognizant when you have a large RSU position vesting. When this happens, you may wait to recognize other variable income, such as capital gains or Roth Conversions.

• Continue diversifying your investment portfolio. Your company’s stock should only be one tool to help you reach your goals, not the entire toolbox. By diversifying, you can balance out the risk-return tradeoff and avoid concentration risk.

Create A Comprehensive Equity Plan

There are many pros and cons to RSUs, just like other types of equity compensation and stock options. It’s critical to have a firm understanding of what kind of options you have and create a comprehensive equity plan to maximize them. Building a solid plan for your RSUs starts with understanding your goals, income picture, and tax outlook. At The Dala Group, we are well-versed in guiding our clients to create efficient and effective plans for their equity compensation. We would love to help you optimize a plan and strategy for your RSUs. Reach out today.