Does your company give you Restricted Stock Units (RSUs) as part of their compensation package? But you're not sure what RSUs are or how they work?
RSUs are a great way to add extra equity to employees and give them a stake in the company. In a 2017 survey of 325 companies, 72% reported using RSUs in their compensation programs compared to only 37% a decade before. A shift towards companies providing a more comprehensive benefits package for their employees.
Are you receiving RSUs as part of your overall compensation and don’t know what to do with them? In this blog, we will discuss how Restricted Stock Units work and what benefits they offer. We will also provide an explanation of how they are taxed and how some popular companies implement them.
What are Restricted Stock Units?
Restricted Stock Units (RSUs) are a type of equity compensation used by many public companies to reward and incentivize their employees. RSUs provide you with shares of your company's stock at a later date, typically after a vesting schedule has been completed. The shares are restricted and aren’t accessible to the recipient until this benchmark passes, hence the name.
The key difference between stock options and RSUs is that with RSUs, you do not have to pay to obtain them. They are given to employees once they meet certain benchmarks such as time at the company, performance, or other criteria. This incentivizes employees to perform well and increases a company's employee retention.
Large companies have shifted away from giving their employees stock options and instead provide them RSUs. In fact, Bill Gates regrets not shifting sooner. At a Microsoft conference, Gates said:
“When you win [with options], you win the lottery. And when you don’t win, you still want it. The fact is that the variation in the value of an option is just too great. I can imagine an employee going home at night and considering two wildly different possibilities with his compensation program. Either he can buy six summer homes or no summer homes. Either he can send his kids to college 50 times, or no times. The variation is huge; much greater than most employees have an appetite for. And so as soon as they saw that options could go both ways, we proposed an economic equivalent. So what we do now is give shares, not options.”
How do Restricted Stock Units work?
Restricted stock units typically fall under a vesting schedule. This means that you will not have full ownership of the RSUs until a certain amount of time has passed (usually four years). Each year, a certain percentage of RSUs will "vest," meaning you will have the right to purchase those shares.
For example, let's say you are granted 4,000 RSUs with a new job offer on January 1st. The vesting schedule might look something like this:
25% vested after one year
50% vested after two years
75% vested after three years
100% vested after four years
This vesting schedule is designed to keep employees with a company for at least a few years while incentivizing them to produce quality results. Since they will not receive all of their RSUs immediately.
If an employee leaves before their RSUs are fully vested, they will forfeit any unvested RSUs. For example, if our employee from above leaves after two years, they would only receive 2,000 RSUs (half of their total grant).
It's important to weigh the pros and cons of this system if you have to choose between a position with RSUs or Stock options.
How are Restricted Stock Units taxed?
Restricted Stock Units are considered taxable income in the year they vest. This means that you will owe taxes on the value of the shares at the time they vest, even if you do not sell them. The amount of tax you owe will depend on your marginal tax rate. You may also owe state and local taxes on RSUs.
If you hold onto your RSUs after they vest, you will also be subject to capital gains taxes when you eventually sell them. Capital gains taxes are currently taxed at a lower rate than ordinary income, so this can be beneficial from a tax perspective.
The Merino Wealth Perspective
While RSUs aren’t new, we’re definitely seeing that they’re growing in popularity. We used to see RSUs sporadically, but now a large number of our clients receive RSUs in some way, shape, or form. Plus there’s a huge variety of ways in which companies execute these benefits.
Some companies, like Amazon, regularly provide RSUs with a back-ended vesting schedule when hiring new talent. This could look like 5% of the shares vesting at 1 year and 40% vesting at year 4. While other companies, like Google, could offer monthly vesting of different share schedules over time, such as 9 shares vesting this month and 24 vesting next month.
And would you believe that these benefits can vary based on the employee’s position within the company? RSUs can be a financial “game-changer” for some, but there’s a lot to consider when you’re looking to best utilize your shares to achieve your goals.
If you need more help understanding RSUs and how they may impact your finances or taxes, you can speak with a professional at Merino Wealth. Our team can help you grow your finances and invest in your future.