Are RSUs part of your compensation package or are you looking at a position that offers RSUs? RSUs can become a significant part of your net worth over time. It’s important that you understand how they work, how they are taxed, and how to manage your RSU compensation. This guide will tell you everything that you need to know about Restricted Stock Units (RSUs).
What are restricted stock units, or RSUs?
RSUs are a form of compensation offered by a firm to an employee in the form of company shares. RSUs are generally subject to a vesting schedule, meaning the stock does not fully belong to the employee until such a time it is vested. During the vesting period, the stock cannot be sold. Once vested, the stock is given a Fair Market Value and is considered taxable compensation to the employee. Once vested, the employee can sell any shares they own.
Examples of companies that offer RSUs as part of employee compensation are Adobe, Akamai, Facebook, Google, and Logitech.
How does an RSU work?
An RSU is offered to an employee, generally as an incentive to stay with the company and help the company perform better. If the company does well, the stock price will increase, which helps the employee’s RSUs increase in value. It’s a win-win.
The company generally releases a set number of the company stock to the employee on a vesting schedule. Here is an example:
John gets an offer of employment from a company who offers him a salary, benefits, and 1000 RSUs. The company will release 200 shares per year for 5 years to John. As these shares vest each year, the Fair Market Value of the shares at the time of vesting is added to John’s taxable income for that year. John pays ordinary income tax on that value.
As they vest, John can choose to sell his shares, keep his shares, or sell some and keep some. They become like any other stock someone would own. If the shares increase in value after they vest, and then John sells the shares, he will pay capital gains tax on the difference between the Fair Market Value in the year of vesting and the sale price.
Why do companies give restricted stock units?
RSUs are a compensation and retention tool for employers. The benefits of a company issuing these is that employees who have shares in the company they work for are more likely to perform in a way that would help the company grow and do better, and in turn that would make their shares do better.
RSUs also serve as a retention tool because if an employee has unvested shares, they’re more likely to stay with the company until the shares vest and the money becomes theirs. If they leave before their shares vest, the company gets to take them back. Another benefit for the company is that the vesting schedule allows the company to dole shares out much more slowly to avoid diluting their shares.
What are the advantages of restricted stock units?
The advantages of a restricted stock unit is that the employee gets to share in the growth of the company they spend their time working for. As the shares vest, the employee can then either keep them or sell them. If the employee sells the shares, they can either use that cash for something now, or reinvest in other investments to diversify their portfolio.
RSUs also allow the employee to feel that they are more a part of a company that they work for because they own a part of the company in the form of shares.
Another benefit of restricted stock units as a compensation tool is that it is quite simple. Once the shares vest, and aren’t in a black out period for selling them, the employee can sell them at any point. Taxes are much more simple than stock options with restricted stock units as well.
What are the disadvantages of restricted stock units?
One disadvantage of having RSUs as a form of compensation is that the money is not yours until the shares vest. If you leave the company or are fired before your shares are fully vested, then those shares go back to the company. You can’t count on the money in the RSU account until it is vested.
Another disadvantage is that your shares are a risk for the company doing well or not. If the company does not do well, the shares can drop in value. As long as the shares are not vested, they are an unfunded promise to pay at the share price the stick is at when it vests.
The other disadvantage to RSU compensation is the taxation. RSUs are taxed as ordinary income as they vest, and the employee has no ability to time their taxes as they would with stock options.
How do RSUs differ from stock options?
Stock options give an employee the right to purchase company stock at a determined price within a specified window of time. If the company stock increases from the time of offer to the time the stock options vests, an employee may be able to purchase the stock at a discounted price from the actual market value at time of purchase. Taxes can be a bit more complicated with Stock Options than with RSUs.
RSUs are much simpler. The employer offers a set number of shares to an employee for various reasons (time in service, job performance, etc). At the time these shares vest, the employer can either release the stock to the employee, who then has the right to sell the shares, or the company can give the cash equivalent of the value of the shares to the employee.
To find out more about restricted stock units, visit the District Capital Management ‘RSU’ blog.