2022 was a fantastic year for employees everywhere. Corporate perks, 10% raises, free gym memberships, unlimited PTO, and kombucha on tap in the breakroom. These killer benefits have led to numerous firms being recognized as “top employers” but at the end of the day, we work because we want more money.
Do you really care about kombucha on tap or a ping pong table? Maybe but probably not. What really matters to all of us is whether we can send our kids to college, put food on the table and buy a home to raise a family in. While the other benefits are nice, more money and stock are nicer and some companies recognize this fact and a result, offer equity (like RSUs, ISOs, and other types of equity compensation).
The question we get all the time is “how do RSUs work?”. Here’s your answer.
Restricted stock units (RSUs) are a type of equity compensation granted by an employer to an employee as part of their remuneration package. Unlike stock options, which give the holder the right to purchase shares at a set price (the strike price), RSUs are actual shares of stock that are awarded to the employee when they vest. The vesting schedule for RSUs is set by the employer at the time of grant and is typically based on the achievement of certain milestones, such as length of service or performance goals. While RSUs have some similarities to stock options, there are also important differences that you should be aware of before making any decisions about your equity compensation. In this blog post, we will discuss what RSUs are, how they work, and some of the key things you need to know about them.
What is a Restricted Stock Unit (RSU)?
An RSU is a type of stock option that is granted to an employee of a company when they are given a job offer or hit a performance milestone. Unlike a traditional stock option, an RSU does not give the holder the right to purchase shares of the company’s stock. Instead, the RSU gives the holder the right to receive a set number of shares of the company’s stock at a set price, usually at the time of vesting.
There are two main types of RSUs: those that are subject to vesting at a future date and those that are not. Vesting RSUs are typically awarded to employees as part of their compensation package. The number of shares that an employee will receive is based on a percentage of their total compensation. For example, if an employee is awarded 100 RSUs and they have a total compensation package worth $200,000, they will receive 50 shares of the company’s stock when the RSUs vest.
Non-vesting RSUs are typically awarded to executives and other key employees as a bonus or performance-based award. The number of shares that an executive will receive is based on their position within the company and their performance during their tenure. For example, if an executive is awarded 1,000 RSUs and they are responsible for generating $10 million in revenue for the company, they will receive 1,000 shares of the company’s stock when the RSUs vest.
Both vesting and non-vesting RSUs have restrictions placed on them that prevent the holder from selling or transferring.
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How Do RSUs Work?
When an employee is awarded RSUs, they are typically given the option to receive the units as cash or as stock on something referred to as a grant date. If the employee opts to receive the units as stock, they will be issued a specific number of shares of company stock at vesting which will happen at a later date in the future. If the employee opts to receive the units as cash, they will be paid out the fair market value of the units on the vesting date.
RSUs are subject to vesting schedules, which means that the employee may not have access to all of the units immediately. Vesting schedules can vary depending on the company, but typically RSUs will vest over a period of several years.
Once the grant vests, employees can do with them as they please. They can sell them, hold onto them, or use them to exercise stock options.
Employees should be aware that taxes may be due on RSUs when they vest. The amount of tax owed will depend on factors such as whether the employee held onto the RSUs or sold them and what their marginal tax rate is. Employees should consult with a tax advisor to determine what taxes may be due on their RSUs.
What Are The Benefits of RSUs?
1. RSUs are a way for companies to reward employees by giving them common stock without having to pay them cash upfront.
2. RSUs can be an excellent way to build wealth over time, especially if the company’s stock price goes up.
3. RSUs can also help you diversify your investment portfolio since they are not 100% dependent on the stock market.
4. Finally, RSUs can provide some stability during periods of economic uncertainty since they are not as volatile as stocks.
What Are The Risks of RSUs?
There are a few risks to keep in mind when it comes to restricted stock units. For one, the stock price could drop significantly and you could be left with less money than you originally invested. Additionally, if you leave the company before the vesting date, you may not receive any of the RSUs. Finally, there is always the risk that the company goes bankrupt and the RSUs become worthless.
Do RSUs have a vesting requirement?
RSUs are subject to a vesting period, which means that you will not have full ownership of the company shares until the shares vest. Your company’s vesting plan can vary, but typically involve a four-year period with a one-year cliff. This means that you will vest 25% of your shares after the first year and then 1/48th of your shares each month for the next 36 months. Once your RSUs have reached their vest date, you’ll incur a taxable event meaning you may have a potentially large tax burden so it’s important to take a closer look at a few different things before they do. Consider your own personal tax situation, your income, the number of shares you expect to receive, and what one share of stock is worth at this point in time.
What is the tax treatment of RSUs?
When it comes to taxes, restricted stock units (RSUs) are taxed differently than regular stocks. RSUs are taxed at the time of vesting, which is when the shares are released and become available to the employee. The employee is then taxed on the value of the RSUs on the date of vesting at ordinary income tax rates. The amount of tax owed will depend on whether the RSUs are considered to be qualified or non-qualified. Keep in mind, many payroll providers withhold tax incorrectly when your shares vest. Oftentimes, they only withhold 22% which could potentially leave you with a huge tax bill come April.
As was mentioned, the fair market value of the stock when your RSUs vest is included in your taxable income for the tax year which means that the actual value of the RSUs is taxed no differently than a cash bonus.
The bottom line is that RSUs can be a great way to receive compensation from your employer, but you need to be aware of the tax implications before you receive them. Talk with your financial advisor to make sure you understand how they will impact your overall financial picture.
How Do RSUs work if you’re employed by a private company?
If you work for a private company, your RSUs will be subject to vesting conditions specified in your award agreement. Similar to working for a public company, RSUs at private companies have vesting conditions that may include continued employment with the company for a certain period of time or achievement of performance milestones.
Once the vesting conditions are met, you will have the right to receive the underlying shares of stock or cash equivalent. The value of your RSUs will be based on the fair market value of the company’s stock at the time they vest which is based on the 409a valuation that the company determines typically at least once per year.
How to Maximize Your RSU Benefits?
If you’re like most people, you probably want to know how to maximize your RSU benefits. Here are a few tips:
1. Depending on your financial goals, consider keeping your stock after it vests. If you don’t need the cash and can afford the tax bill out of pocket, then there’s nothing wrong with keeping the shares and hoping that you hear some good news about the company’s performance. This could be especially valuable if you’re an employee of the company at an early stage. Your vested RSUs could be worth more than you realize if your startup grows into something substantial. Keep in mind, this isn’t investment advice and your company may fail as well.
2. Aim to max out your tax-advantaged accounts in the year that your RSUs vest.
If you have a 401k, HSA, 457 plan, IRA, or any other pre-tax accounts, you can aim to max these out to decrease your taxable income in the IRS’s eyes, meaning that you’ll pay a lower tax rate on your RSUs as a result. This isn’t tax advice but this is something to consider. Talk to a financial planning expert or a tax professional if you’re not sure what to do.
3. Diversify your portfolio.
Don’t put all of your eggs in one basket by investing everything into company stock. Instead, diversify your portfolio by investing in other types of assets such as stocks, bonds, and mutual funds. This will help reduce risk and make sure that you don’t lose everything if the company’s stock price takes a dive. If over 10% of your net worth is
Conclusion
If you’re considering accepting restricted stock units (RSUs) as part of your compensation package, it’s important to understand what they are and how they work. RSUs are a type of stock that is awarded to employees by their employer, typically as a form of long-term incentive compensation. Unlike traditional stocks or stock options, RSUs are subject to vesting conditions that must be met before the employee can exercise them. Vesting conditions may include remaining employed with the company for a certain period of time or achieving specific performance milestones.
While RSUs can be a valuable form of compensation, it’s important to understand the implications before accepting them. For example, you will not have any control over when you can sell your shares and you may be subject to taxes on the shares when they vest. Additionally, if your employer’s stock price decreases after you receive your RSUs, you could end up losing money on the investment. However, if the company’s stock price goes up and you hold onto your shares until they’re fully vested, you could see a nice return on your investment.
