What Are RSU Grants and How Do They Work?
Understand Restricted Stock Units (RSUs): their fundamental nature, how they function, and their financial implications.
Restricted Stock Units (RSUs) are a common form of employee compensation, especially in publicly traded companies. This equity-based reward system offers employees a stake in the company’s future success. Understanding how RSUs function, from their initial grant to their eventual conversion into shares, is important for individuals managing their compensation.
Defining Restricted Stock Units
A Restricted Stock Unit represents a promise from an employer to deliver shares of company stock to an employee at a future date. This promise is contingent upon satisfying specific conditions, most commonly continued employment over a set period. Unlike actual stock, RSUs do not confer ownership, voting rights, or dividends until they vest. Until vesting occurs, an RSU is essentially a contractual right to receive shares later.
RSUs differ from stock options: they always possess inherent value as long as the company’s stock price is above zero. Stock options, conversely, provide the right to purchase shares at a predetermined price. If the market price falls below that exercise price, the options can become worthless. This distinction means RSUs offer a more predictable form of compensation compared to options, which can fluctuate more dramatically.
Mechanics of RSU Grants
The journey of an RSU begins on the “grant date,” when the company formally awards the units to an employee. At this point, the employee does not own any shares; the grant date merely marks the starting point for the vesting period. The number of units granted is typically communicated, often alongside an estimated dollar value based on the stock price at the time of the grant.
Following the grant, RSUs are subject to a “vesting schedule,” which dictates when units convert into actual shares. Common vesting schedules include “cliff vesting,” where all units vest at once after a specified period, such as one year. “Graded vesting” is another structure, where a percentage of the units vests at regular intervals over several years, for example, 25% each year over a four-year period.
Once RSUs vest, the company delivers the actual shares to the employee. This delivery usually occurs shortly after the vesting date, with shares typically deposited into the employee’s brokerage account. The transfer of shares signifies that the employee has met the predetermined conditions, granting full ownership.
Tax Implications of RSU Vesting
The vesting of Restricted Stock Units triggers a taxable event for the employee. The fair market value of the shares received is considered ordinary income. This income is treated similarly to regular wages or a cash bonus and is subject to federal, state, and local income taxes, as well as Social Security and Medicare taxes.
Employers typically manage this tax obligation by withholding a portion of the vested shares or their cash equivalent. For federal income tax, a statutory withholding rate of 22% generally applies to supplemental wages. A higher rate applies to amounts exceeding $1 million. This standard withholding might not cover an individual’s full tax liability, particularly for higher earners, potentially leading to additional taxes owed at filing time. The income from vested RSUs is reported on an employee’s Form W-2.
Why Companies Utilize RSUs
Companies frequently use RSUs as a compensation tool to attract and retain skilled talent. The multi-year vesting schedules create a strong incentive for employees to remain with the organization. This structure helps reduce employee turnover, as individuals must stay for a specified period to realize the full value of their awards.
RSUs also align employee interests with the company’s financial performance. As the value of the RSUs is tied to the company’s stock price, employees are motivated to contribute to the company’s success, which can lead to stock appreciation. This fosters a sense of ownership among employees, encouraging them to work towards shared objectives that benefit all shareholders. Finally, RSUs offer companies a flexible compensation option that does not require an immediate cash outlay, allowing them to conserve capital while still providing competitive remuneration.