What is an RSU? Restricted Stock Guide for Executives

The value of RSUs or stock options to employees depends on the company and the individual. There is no one-size-fits-all equity compensation solution, and both can have a meaningful impact on an employee’s financial future. 

While RSUs may appeal to people with a lower risk tolerance seeking predictable returns, stock options may appeal to employees with a higher risk tolerance who are willing to risk the possibility of the stock losing value for the chance of a larger payout.

Key Considerations for RSUs

Financial situation and risk tolerance carry significant weight, but they aren’t the only considerations when evaluating RSUs. Other factors to consider include:

• Company performance: A company’s performance can provide a rough idea of the future value of its RSUs. If the company performs consistently well over time, its stock will appreciate, thereby increasing the value of its RSUs.
• Vesting schedule: Also known as a vesting period, this is the time it takes for RSUs to become actual shares. Short vesting periods are preferable to long ones.
• Share liquidity: In public companies, employees can sell their shares right away. However, private companies may have additional restrictions that hinder employees from selling their shares immediately. 
• Employment status: If an employee leaves before their RSUs vest, they forfeit any unvested RSUs to the company. This makes them unappealing to employees who don’t intend to stay long term.

 

At JNBA, we offer a tailored approach to helping executives navigate RSUs and other equity-based compensation. 

How Are RSUs Taxed?

RSUs are taxed at two stages: when they vest and when they are sold.

Taxation at Vesting

At vesting, the IRS treats the fair market value (FMV) of RSUs as ordinary income. This means RSUs are subject to federal, state, and payroll taxes, including Social Security and Medicare taxes.

The FMV is the value of the RSUs at the time they vest. It’s usually specified in an RSU agreement and determined by the company’s stock price on a particular date, often the vesting date. It’s calculated as the average of the day’s high and low prices, or sometimes the previous day’s close or the real-time stock price.

For instance, if an employee receives 1,000 RSUs and the share price is $10 on the vesting date, the RSUs will be worth $10,000 (1,000 RSUs x $ 10 = $10,000). This additional $10,000 will be added to the employee’s annual taxable income. 

As a result, income from restricted stock vesting may push an employee into a higher tax bracket, leading to additional taxes when filing returns.

Taxation When Selling RSU Shares

RSU shares are subject to capital gains tax if they are sold at a profit. If sold within less than a year of vesting, they are treated as short-term capital gains and taxed as ordinary income. If held for over a year, they are treated as long-term capital gains and taxed at a lower rate, up to 20%, depending on income.

What ”Sell to Cover” Means

Many companies may automatically withhold a portion of vested shares to cover federal, state, and local taxes. This is commonly known as the ”sell to cover” method.

For example, if an employee’s federal withholding tax is $20,000 and the RSUs vest at $100 per share, the employer would sell 200 shares to cover the employer’s taxes.

The primary benefit of “sell to cover” is that it allows employees to meet tax obligations without requiring any upfront cash. However, a potential downside of the method is that the automated tax withholding might not cover an employee’s entire tax liability.

Selling Restricted Stock Units

Holding a large concentration of stock in a single company can increase risk. As a result, financial advisors often recommend selling a portion of RSUs to have a diversified portfolio and minimize risk. Key considerations to keep in mind when selling RSUs include:

• Cash-flow needs: Selling RSU can be an excellent way to access liquidity for other needs, such as buying a home or paying for college.
• RSU tax implications: While selling RSUs immediately they become vested reduces risk, holding onto them for more than a year can be a savvy way to qualify for lower capital gains tax rates.
• Company performance: If a company’s performance is declining, it might be prudent to sell its RSUs before they depreciate further or become worthless.

 

Are you navigating a career transition and thinking about selling your RSU shares? JNBA offers a no-obligation consultation for executives. 

RSU Frequently Asked Questions

What is RSU Income?

RSU income is a type of equity-based compensation that employees receive from their employer in the form of company stock. Since it is treated like ordinary income, it appears on their W-2. As a result, RSU income is subject to federal, state, and local taxes, affecting overall taxable income and take-home pay.

Do Restricted Stock Units Have Voting Rights?

RSUs don’t grant employees voting rights until actual shares get issued to them at vesting. This means that employees don’t have a say in company decisions, such as electing board directors, approving dividends, or issuing new securities. 

What Happens to RSUs When You Leave the Company?

If an employee leaves or is terminated, they forfeit the unvested RSUs to the company. However, the employee retains ownership of vested RSUs and can choose to sell or hold them. 

Is it Better to Take RSUs or Stock Options?

The best choice depends on the individual and their financial situation. RSUs require no upfront cash and offer greater certainty, often making them better suited for individuals with a low risk tolerance who don’t want to invest their own money.

In contrast, stock options require upfront cash to exercise and offer greater potential upside, making them typically better suited for individuals with a high-risk tolerance and cash to invest.

Connect with JNBA for Professional Financial Guidance for Restricted Stock

Restricted stock units can be an attractive form of equity compensation for both employers and employees since they align the interests of both parties by tying compensation directly to the company’s long-term success. 

Whether you’re an employee considering selling your RSUs or an employer looking to help your executives understand the value of the compensation tool, JNBA can help you with RSUs and executive financial planning services. Our team has provided clients with professional insights about compensation and benefits for decades. Contact us today to connect with one of our financial advisors.