RSUs (Restricted Stock Units)

Nowadays, most tech companies, such as Google and Microsoft, are offering RSUs Restricted Stock Units to their employees as a form of future reward.

For a beginner, understanding the basics of an RSU can be a head-scratcher. The complicated tax rules and guidelines regarding the vesting period can be difficult to understand. In basic terms, RSU is a form of equity compensation offered by employers to their employees. The employer promises the employees to give them company shares in the future based on certain conditions.

What is an RSU? | RSUs (Restricted Stock Units)

An RSU, which stands for Restricted Stock Unit, is similar to a bonus, but instead of getting the amount in cash, the employees get the reward in the form of company shares. These company stocks are labelled “restricted” because they are based on a specific vesting schedule predetermined by the employer. Some grants are based on the length of tenure of the employees while others are based on the overall performance of the employees.

The employees get the shares after the vesting date. Before that, they don’t have voting and dividend rights. As the vesting period proceeds, it adds to the overall income and net worth of the RSU holder.

While these restricted grants might not offer shortcuts to accumulate wealth in a short period as stock options, they offer a more stable and gradual progress route to the employees. The employees would also be able to easily track the current value of their restricted stocks, unlike standard shares that have theoretical values. Also, unlike standard stocks, restricted stocks always have some monetary value attached to them – even if the market price drops below the price on the grant date.

How Do They Work? | RSUs (Restricted Stock Units)

RSUs are given to employees at special events in an organization, such as when a new employee joins the company or the company manages to gain huge profits in a short period. Depending upon the company policy, RSUs may be awarded annually or on a semi-annual basis.

Two main dates are highly important when it comes to dealing with RSUs, which are grant dates and vesting dates.

• Grant Date: This is the date on which an employer grants a specific quantity of stocks to an employee. Acquiring this grant doesn’t increase the current income of the employee, as they are not able to convert it into cash yet. Also, tax is not imposed on the holder of RSU during the grant period.
• Vesting Date: After granting the RSU, the employers establish a specific vesting schedule, which is a time-based reward system. The employees would be expected to spend a minimum tenure at the company before they can get the ownership of the restricted shares.

Standard vesting periods are 6 months or 12 months, or they can last sometimes last longer than that. There are usually two types of vesting schedules: cliff vesting and graded vesting.

In cliff vesting, a specific portion of stocks vests at once, and then the remaining amount vests on a monthly or quarterly basis.

On the other hand, in graded vesting, the restricted stock units are handed over to the holder over regular intervals throughout the ownership tenure. Most companies follow a hybrid vesting schedule in which the first quarter of the shares is vested after the first year, and then the remaining grant vests each month until the completion of the grant vesting period.

How Are RSUs Taxed? | RSUs (Restricted Stock Units)

The employees are not required to pay tax once the RSUs are granted but they would become liable to pay taxes upon vesting. Unlike non-qualified stock options (NSOs) that are subjected to complex tax rules, the tax payment procedure of RSUs is quite straightforward. These restricted stock options are treated as regular income in terms of tax payment. The stock owners would have to pay the tax related to the market value of the stocks at vesting.

Upon the sale of the RSU, any change in the price of the restricted shares would be treated as a capital gain or a capital loss. This means that the stocks holders would be required to pay tax on the net profit when they sell the restricted units.

What is the Difference Between RSUs and Standard Stock Options? | RSUs (Restricted Stock Units)

To a novice individual, RSUs and stock options might look similar but they both have a different mechanism of stock ownership and cash out method. Upon vesting of the stock options, the employees are given the chance to purchase them at a discounted rate. On the other hand, when the restricted units vest, they instantly come under the ownership of the designated employee.

While the extra income from the sale of RSUs is a boon for the employees, it is always better to consult with a financial advisor, as it can potentially result in a higher tax bracket due to an increase in the net assets.

What to Do with RSUs? | RSUs (Restricted Stock Units)

After the vesting date, the owners of the restricted units have to decide whether they want to hold it or sell it to get cash in return. For starters, it is advised to inspect the current progress rate and past track record of the company. The clients should also analyze the performance of the organization’s shares in taxable and retirement accounts. This would put the employees in a better position about whether they want a stake in the company or not.

If the clients want to expand their investment portfolio, then it is better to sell the RSUs upon vesting date and reinvest the proceeds in the top-trending stocks of the company. To reduce investment risk, the clients should only keep about 10% of RSU compared to their overall net worth. Concentrating all the investment in a single stock option can increase the odds of losing money.

Conclusion | RSUs (Restricted Stock Units)

RSUs (Restricted stock units) prove to be an integral element of an employee’s overall compensation package in the company. The clients can build a tax-wise plan to expand their investment portfolio. To reduce the odds of facing unforeseen financial losses, it is always advised to hire a trustworthy financial advisor.