This article was written by Danika Waddell, CFP®, RLP®, CSLP® at Xena Financial Planning.
One of the most common issues facing my clients is how to manage their equity compensation, specifically restricted stock units (or RSUs). If you work in the tech industry, there’s a good chance that you receive RSUs as a part of your total compensation package. They can be a huge upside for you, if they are managed well, but they can also be very risky.
What the heck are RSUs?
Let’s start with what RSUs are and how they typically work. For the sake of this article, I’ll be referring to RSUs in a publicly traded company (think Amazon, Meta or Salesforce). Essentially, your company has awarded you some kind of bonus but you don’t actually get it right away. Bummer. A cash bonus is pretty easy to understand, right? A “bonus” in the form of RSUs just takes a little longer to receive. You have to wait for the shares to vest. If your employer grants you 100 shares of Amazon stock, vesting over 4 years, you don’t have to do anything at all today. You will receive 25 shares of Amazon stock that vest each year for the next 4 years.
In other words, based on the vesting schedule, your RSUs will come to you over a period of time. You don’t have to do anything to get them. In that regard RSUs are a lot more straightforward than stock options. The only decision you really have to make is when to sell them.
An example of how this works:
As mentioned above, your company grants you 100 RSUs vesting annually over 4 years (many companies actually have shares that vest monthly or quarterly, but for the sake of simplicity, let’s assume they vest annually only).
1/1/2020: company grants you 100 shares
1/1/2021: the first 25 shares vest
1/1/2022: another 25 shares vest
1/1/2023: another 25 shares vest
1/1/2023: the final 25 shares vest
When your shares vest, your company will sell a portion of what vests to cover the taxes. In many ways, this is great! They sell some for taxes, pay the IRS, and the rest is yours. Instead of 25 shares, you might receive 19 after taxes. The challenge is that most companies sell only the statutory minimum of 22%. A lot of people get burned by this when tax time comes around. Imagine you’re in the 35% tax bracket but your company only withheld 22% for taxes. You’re going to owe the IRS a chunk of change, which you may not have handy (unless you sell some of your shares). If you have done some tax planning, and you’re prepared for this tax hit, you’ll be fine. But there are plenty of folks who are caught by surprise in this situation.
Another factor regarding the taxes is what happens when you decide to sell your remaining vested shares. When you sell your vested shares, you will owe taxes again (either short-term or long-term capital gains) on the growth from the value at vesting to value when you sell. Many people think there’s a long-term tax benefit to holding the shares for 12+ months after they vest. I can almost guarantee one of your co-workers has suggested this to you. However, if you sell your RSUs as soon as they vest, there will be virtually no gain (i.e. growth) from the value at vest. In fact, the longer you hold your RSUs, the riskier they become as the share price is not guaranteed to go up (try telling that to a long-time Amazon employee!).
Why are RSUs risky and how should you think about them?
The reason why holding RSUs is risky, is that your company’s stock price is not guaranteed. It could certainly go up, but it can just as easily go down. If you have a large percentage of your net worth tied up in your company stock, not to mention having your salary + benefits tied to your employer, this could be pretty nerve-wracking.
One of my favorite ways to frame this for clients is this: “If your employer gave you a cash bonus (instead of RSUs), would you invest it in your company stock?” I have yet to meet someone that says yes. It’s very easy to get caught up in emotions with RSUs, but I find this way of looking at them to be very useful. In many cases, it makes sense to sell them and do something else with the proceeds (invest in a more diverse set of funds, use towards other short/long-term goals), but there is no one-size fits all advice here. I recommend you talk with a financial planner who understands RSUs and ideally also work with a tax preparer who is proficient in this capacity. Together with these professionals, you can devise a strategy for managing your RSUs.
The information on this site is not intended as tax, accounting or legal advice, as an offer or solicitation of an offer to buy or sell, or as an endorsement of any company, security, fund, or other securities or non-securities offering. The information on this site should not be relied upon for purposes of transacting in securities or other investment vehicles. The information on this site is provided “AS IS” and without warranties of any kind either express or implied. To the fullest extent permissible pursuant to applicable laws, Western Washington Financial Advisors Network (WWFAN) disclaims all warranties, express or implied, including, but not limited to: implied warranties of merchantability, non-infringement, and suitability for a particular purpose. WWFAN does not warrant that the information will be free from error. Your use of the information is at your sole risk. Under no circumstances shall WWFAN be liable for any direct, indirect, special or consequential damages that result from the use of, or the inability to use, the information provided on this site, even if WWFAN or a WWFAN authorized representative has been advised of the possibility of such damages. Information contained on this site should not be considered a solicitation to buy, an offer to sell, or a recommendation of any security in any jurisdiction where such offer, solicitation, or recommendation would be unlawful or unauthorized. The information being provided is strictly as a courtesy/convenience. When you link to any of the websites provided here, you are leaving this website. We make no representation as to the completeness or accuracy of information provided at these websites. WWFAN is not liable for any direct or indirect technical or system issues or any consequences arising out of your access to or your use of third-party technology, websites, information and programs made available through this website. When you access one of these websites, you are leaving our website and assume total responsibility and risk for use of the websites you are visiting. WWFAN does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to WWFAN’s website or incorporated herein, and takes no responsibility thereof.