What to Do With Your Restricted Stock Units

Restricted Stock Units (RSUs) are a common form of equity compensation. They represent a promise from an employer to deliver company stock or its cash equivalent at a future date, not actual shares when granted. Managing RSUs after they are granted and as they vest is important for optimizing one’s financial position. This article clarifies the actions and decisions individuals face regarding their RSUs.

Understanding Restricted Stock Units

Restricted Stock Units are a form of employee compensation where a company promises to give an employee shares of its stock once certain conditions are met. These conditions typically involve a “vesting” period, during which the employee must fulfill specific requirements, such as continued employment for a set duration or the achievement of performance milestones. RSUs do not have tangible value or voting rights until they fully vest.

Vesting is when ownership of the shares becomes unconditional. Vesting schedules vary, but common types include time-based vesting, where a portion vests at regular intervals (e.g., 25% per year over four years). Cliff vesting releases a large portion or all RSUs at once after a specified period, often one year. Performance-based vesting ties the release of RSUs to company or individual performance targets.

Unlike stock options, RSUs do not require the employee to pay an exercise price to acquire the shares. Stock options grant the right to purchase company shares at a fixed price, known as the strike price, before a certain date. RSUs, conversely, represent an actual grant of stock, meaning the employee generally receives the shares without a purchase cost once vested. This distinction means RSUs typically retain some value as long as the company’s stock has value, whereas stock options can become worthless if the market price falls below the exercise price.

Tax Considerations at Vesting

When Restricted Stock Units vest, their fair market value on the vesting date is considered ordinary income for the recipient. This means the value of the vested shares is subject to various taxes, including federal income tax, state income tax (if applicable), Social Security tax, and Medicare tax. The full value of the vested RSUs is included on the employee’s W-2 form for the year they vest, similar to regular wages.

Companies typically employ methods to withhold taxes at the time of vesting. One common approach is “sell to cover,” where a portion of the newly vested shares is automatically sold to generate funds to cover the employee’s tax obligations. The remaining shares are then delivered to the employee’s brokerage account. Another method is “net share settlement,” where the company simply delivers fewer shares to the employee, with the value of the undelivered shares being equivalent to the tax withholding amount.

The cost basis of vested shares is their fair market value on the vesting date. This amount is reported as ordinary income. For instance, if 100 shares vest at $50 per share, $5,000 is recognized as ordinary income, and the cost basis is $5,000. This tax event occurs at vesting, regardless of whether the shares are sold or held. Tax liability arises even if shares are not immediately sold.

Making Decisions After Vesting

Once RSUs vest and initial tax obligations are handled, individuals decide whether to sell or hold their shares. Selling immediately allows for asset diversification, reducing concentration risk in a single company’s stock. It also provides liquidity for financial needs like paying down debt, building an emergency fund, or funding a home down payment. If shares are sold immediately after vesting, there are typically no significant capital gains or losses, as the sale price is close to the cost basis.

Alternatively, individuals may choose to hold their vested shares. This decision is often based on a belief in the company’s continued growth or as part of a long-term investment strategy. Holding shares means they remain subject to market fluctuations, and their value can increase or decrease over time. If the shares are held and later sold, any difference between the sale price and the cost basis (the fair market value on the vesting date) will result in a capital gain or loss.

The tax implications for capital gains or losses depend on the holding period after vesting. If the shares are held for one year or less after vesting before being sold, any profit is considered a short-term capital gain, taxed at the individual’s ordinary income tax rate. If the shares are held for more than one year after vesting, any profit is classified as a long-term capital gain, which is generally subject to lower tax rates. Conversely, if the shares are sold for less than their cost basis, a capital loss is incurred, which can be used to offset other capital gains and, to a limited extent, ordinary income.

Several factors influence the decision to sell or hold vested shares. Personal financial goals, such as retirement planning or saving for a major purchase, play a role in determining the need for liquidity. Current financial obligations and risk tolerance also impact this choice; individuals with significant debt or a low tolerance for market volatility may prefer to sell. The overall concentration of wealth in company stock is another important consideration, as over-concentration can expose an individual to undue risk if the company’s performance declines.

Integrating RSUs into Your Broader Financial Strategy

Integrating vested RSUs into a broader financial strategy is important for long-term financial health. Vested RSUs transform into company stock, becoming part of an individual’s investment portfolio. Asset allocation and diversification are key, as concentrating assets in one company’s stock exposes individuals to substantial risk. Financial professionals recommend diversifying investments across various asset classes to mitigate potential losses.

Proceeds from vested RSUs, whether sold or held, can contribute to long-term financial goals. Funds can be directed towards retirement planning, supplementing 401(k)s or IRAs. They can also be used for major life events, such as a down payment for real estate, education expenses, or establishing an investment portfolio. Strategic deployment of these assets aligns with financial objectives.

Vested shares should also be considered within an estate plan. Incorporating these shares into an estate plan involves determining how they will be distributed to beneficiaries upon the owner’s passing. This process often includes reviewing beneficiary designations on brokerage accounts holding the shares and potentially including provisions in a will or trust. Estate planning for appreciated stock can involve complexities related to stepped-up basis rules, which may reduce the capital gains tax burden for heirs.

Charitable giving is another strategic option for appreciated shares. Donating vested shares directly to a qualified charity can be a tax-efficient strategy. This allows donors to claim a tax deduction for the fair market value while avoiding capital gains taxes from a sale. This supports philanthropic interests and optimizes tax outcomes.

Given the complexities of managing equity compensation, consulting a qualified financial advisor or tax professional is advisable. These professionals provide personalized guidance to navigate tax implications, investment decisions, and long-term financial planning. They help integrate RSUs into a comprehensive financial strategy.