5 Things to Consider with Restricted Stock Units
Posted February 25, 2022
Restricted stock units— maybe you’ve seen the term in a benefits package, heard leadership teams talking about it, or read about it in the news, but you never knew what it meant. Well, we’re here to be your partner in prosperity and provide clarity on the subject.
By definition, a restricted stock unit (RSU) refers to a form of compensation an employer gives to an employee in the form of company shares. These RSUs are typically issued to employees through a vesting plan and distribution schedule after reaching performance milestones or being with the company for a set amount of years.
The term vesting is crucial in understanding restricted stock units. Vesting means giving or earning a right to a present or future payment, asset, or benefit. It is often used about retirement plan benefits when an employee earns nonforfeitable rights over employer-provided stock incentives or contributions made to their retirement or pension plan.
Nonforfeitable rights are critical to understanding because no tangible value is given until vesting is complete, which can take several years. When the RSUs vest, they are assigned a fair market value (FMV). Once fully vested, they are considered income, and the employee will owe income taxes on receipt of those stock shares. At this point, the employee is typically free to sell the shares at their discretion.
If you are considering RSUs as a way to invest and save for retirement, here are five things to consider.
Consider the Advantages of RSUs
Restricted stock units can offer advantages to both you and the company. RSUs incentivize you as an employee to take stock, literally, in the company’s success. If your employer’s stock price increases while you own the RSUs, you will receive a bigger “bonus” when those shares finally vest.
On the employer’s side, RSUs give employees a reason to stay with the company for an extended period, which could be especially beneficial during times like the Great Resignation. If the employee leaves the company before their RSUs vest, they surrender the RSUs and that economic benefit. Additionally, administrative costs are minimal, and the dilution of the company’s shares is spread over time because of the vesting schedule.
Consider the Disadvantages of RSUs
Although there are benefits of RSUs, such as employee incentives and low administration costs, there are also disadvantages. One of the primary disadvantages is that RSUs do not provide dividends because the shares are not allocated.
A second disadvantage is that RSUs are included in gross income for tax purposes and are recognized on the vesting date. Because they are considered income, the value of vested shares gets added on top of your W2 income, which could boost you into higher tax brackets. Also, the IRS does not consider them to be tangible property. Therefore, RSUs are not eligible for the IRC 83(b) Election, which allows an employee to pay tax before vesting.
A third disadvantage to RSUs is that employees can risk forfeiting shares if they do not reach the vesting date. For instance, if your vesting schedule consists of 3,000 RSUs over three years and you leave after one year, you may risk forfeiting 2,000 RSUs.
Consider Potential RSU Grant Issues
Do you need to confirm the conditions of vesting? Does your plan allow you to defer the distribution of shares and continue to hold units until a later date, post-vesting? Do you need to review what you will receive when your RSUs vest? Does your company accrue/pay dividend equivalents while you hold RSUs? These are all critical questions to ask when evaluating potential restricted stock unit grant issues. The answers to these questions could affect your cash flow and tax liability down the road.
Consider Potential RSU Investment Issues
If shares of your company’s stock, along with any unvested RSUs, make up a significant percentage of your investment portfolio, it is essential to consider tax-efficient diversification strategies. Maintaining a concentration in your company’s stock can be a risky strategy.
While considering potential investment issues, ask yourself if you will need downside protection while holding your company’s shares. If so, consider whether buying put options (if permitted) or investments with negative correlation would offer a safeguard.
Consider Potential RSU Tax Issues
Remember, being awarded RSUs is not a taxable event. Income is not recognized until the shares (or cash) are delivered upon vesting. If you are looking to reduce your income tax liability in the year that your RSUs vest, you may want to consider a bunching strategy. Bunching will allow you to time your deductible expenses and maximize your ability to take itemized deductions, and reduce your tax liability.
Will you need to plan for tax withholding in the year of vesting? Do you need help determining your cost basis in any shares acquired at vesting? Do you need help deciding your holding period for shares acquired through your RSU plan? These are all critical questions to discuss when considering the restricted stock unit tax issues you may encounter.
How Thayer Financial Can Help
There are many issues to consider in the realm of Restricted Stock Units, and the Thayer Financial team can help you address every one of them. Thayer Financial’s CFP team can help you from the initial understanding of what an RSU is to the issues you will encounter through the vesting period and after the vesting date has been reached. Thayer Financial is a Registered Investment Adviser and is held to a fiduciary standard at all points in the client relationship. Being a fee-only fiduciary means we are always working with your best interest in mind.
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