Restricted stock units, or “RSUs” for short, allow companies to grant shares to their employees. While “traditional” stock options can effectively lose their value if the company stock price is below the “strike” or “exercise” price, that is not the case for RSUs. They are usually worth something, regardless of how low stock prices get (assuming the company stays in business!). That means these equity awards can be valuable.
Employees who receive RSUs from their employer cannot use them until they “vest”–that is, they get converted from restricted units to actual shares of stock. At that point, your RSUs are taxable earned income, and your earned income is a simple calculation of the stock price on the day of vesting multiplied by the number of shares vesting that day.
Example: You have six hundred shares vesting and today’s stock price is $150 per share. You will have $90,000 of income recognized today.
If you work at a technology company, there is a good chance that you are eligible for RSUs along with your other benefits. Keep reading for a thorough overview of what you need to know about RSUs.
Do Tech Companies offer RSUs To Employees?
In 2022, some tech companies will offer RSUs. There are some exceptions, however. You are considered ineligible for these stock grants if you work fewer than 30 hours each week. Additionally, employees at certain job levels cannot receive RSUs. Assuming you do not fall into either of these categories, your company may extend this benefit.
How Many RSUs Do Most Employees Get?
There is not a static number of RSUs that an employee receives when they get hired. Instead, you will usually receive a certain number as part of your compensation package, based on the target compensation level of your level and role. That is sometimes due to a company’s desire to align its employees’ interests with its interests as a company. By letting its workers own a small part of the business, a tech firm hopes to encourage them to prioritize its success.
You will receive an RSU Award Summary when you start working at your firm (in most cases). Employees often get added RSU grants annually, most commonly during their yearly review and compensation adjustment, which happens in Q1 of each year. Depending on the company, if you are new, you typically will not get added shares awarded at your first review, so do not be alarmed if this happens to you.
When do the RSUs Vest?
While most employee RSU grants vest at a rate of 25% each year over four years, that isn’t the case at all firms. Instead, let us imagine that XYZ company’s on-hire RSU vesting schedule may work as follows:
Year 1: 5% of the initial grant will vest at the end of your first year.
Year 2: 15% of the grant will vest at the end of your second year.
Year 3: 20% of the grant will vest at the six-month point of your third year, and the grant will vest at the same rate at the 12-month mark, for 40%.
Year 4: The grant will be identical to the plan for the third year.
If you are finding it difficult to follow this schedule, looking at an example might help. To start, let us say you are granted $500,000 in RSUs. This would be converted to a first grant of 4,000 shares, assuming a $125 per share stock price on your grant date. To keep things simple, we will assume that the price of XYZ company stock will stay the same over the four-year grant period AND we will ignore taxes. Here is how that grant would be vested over the next four years:
- 5% of your initial grant ($25,000) would vest when you hit your one-year anniversary with XYZ.
- At your second anniversary, another 15% ($75,000) would vest.
- Instead of waiting another year before the next 20% ($100,000) vests, this would happen six months later and again at your third anniversary—a total of $200,000 for the year.
- The schedule for the third year would repeat in the fourth year. You will have $500,000 in vested RSUs.
One more thing to note: This is how the non-standard vesting schedule for RSUs may work, but that might change soon. XYZ might switch to a monthly vesting schedule for at least some of its employees to boost employee retention.
As mentioned above, once you have completed your second year with XYZ, you will be eligible for another RSU grant. Depending on how the stock performed and how you are ranked in your role, you may or may not receive more RSUs. But even if you do, they typically will not vest until at least year four and sometimes year five.
RSU grants awarded during annual performance reviews usually vest in May and November. They do not necessarily follow a consistent schedule either, so do not expect 2,000 shares to be perfectly distributed to vest 500 every May and November. XYX may be one company that uses the stock value at vest to determine your target compensation band in that current compensation year. Many companies ignore the value at vest and instead figure out their award value at grant, regardless of what those shares are worth at vest.
Once your sign-on stock grant is fully vested after year 4, things get simpler because your vests will almost always follow a May/November schedule.
There are some exceptions to this, like if you take a leave of absence or are at a level where you receive quarterly vests. But most employees receiving RSUs vest on this May/November schedule.
TAX TREATMENT
Of course, it is wise to have an investment plan in place for your RSUs well before they hit their vesting date. When that time comes, you will have two basic options to get started:
- Selling RSUs for taxes. To take this option, sell enough shares to pay off the withholding taxes on the value of your shares. Then, hold the rest of the proceeds in XYZ shares. Remember, you will get the shares based on their price on the vesting date. This is called a “sell-to-cover” transaction, and the default is 22%. If you receive 2,000 shares, they will automatically sell 22% of them and send them in for Federal tax withholding. Early in the year, withholding will be slightly higher to cover Medicare and Social Security tax, typically 28% total withholdings.
- This default is the minimum recommendation and best practice for vesting shares. We do not recommend that you change this to not withhold for taxes and instead plan to pay your tax bill with cash at the end of the year.
- Selling RSUs for cash. That is as simple as it sounds–you will sell your shares and get the proceeds. Note that this will still incur the default sell-to-cover amount listed above, and it should so that you do not potentially have a large, unexpected tax bill at the end of the year.
Note that depending on the level of your RSU income, the 22% sell-to-cover default will be nowhere near enough tax. If you find yourself owing a lot of taxes each year, you may want to increase your default withholding amount. You should be able to change your election for a single grant or all earlier and future grants.
For those subject to trading windows, you can only make a change to your tax election during an open window.
What Can Be Done with RSUs After They Vest?
After you have figured out how to collect your RSUs, it is time to decide what you want to do with the money. There are countless investment opportunities worth considering, such as:
- You are boosting your 401(k) contributions. If you are having trouble maxing out your 401(k) with just your base salary, you can sell shares to boost your cash position, allowing for larger 401(k) contributions. Note that you cannot contribute RSUs directly to your 401(k). A payroll deduction is the only way to contribute to a 401(k).
- Contributing to a 529 account. Are you trying to support your children’s higher education? If so, a 529 account can help you prepare for that.
- Adding to your savings. If you do not have any pressing financial issues to deal with, RSUs can make it easy to build a nest egg.
- Preparing for emergencies. No one knows what will happen to their finances in the future. This is the perfect time to do so for people who have not already created an emergency fund. Also, many folks working at tech firms are subject to trading windows, meaning they cannot sell whenever they want! Do not get caught needing cash while you cannot sell your shares! (this happens to at least a handful of our clients each year)
- Have some fun. It’s not all about saving. We advise our clients on how to spend their money (responsibly), so they get to enjoy the lifestyle they want while still achieving their financial goals.
How to Know You’re on the Right Path
When you understand how they work and have a solid investment strategy, RSUs can serve as a considerable contribution to your wealth building. Despite this, managing RSUs and other benefits without having confidence or context can lead to spending too much or saving too little.
Take control of this financial opportunity and get a plan in place. It is a good idea to get expert advice on how you can utilize your RSUs to the fullest. Working with a financial planning firm specializing in your unique compensation structure is essential. It makes your life easy, so you do not have to explain all the intricacies of your company’s benefits! Also, ensure that the firm you work with is a fiduciary.
You should consider working with Living Your Wealth while creating a plan for your company RSUs. Living Your Wealth specializes in working with Tech Professionals, and we communicate clearly and simply (without the jargon) with our clients. If you are looking for financial professionals who see the people, they work with as people, set up a complimentary introductory call.
