Restricted stock units (RSUs) are an increasingly popular form of compensation given to key employees and company executives. If maintained properly, RSUs can be effectively leveraged for a child’s education, purchasing a home, retirement, estate planning, or a host of other important financial goals. While they are versatile and tremendously beneficial, RSUs can be vastly misunderstood and under-utilized without proper management. This complexity often leads one to overlook this part of their portfolio, and consequently miss out on crucial planning techniques and opportunities.
Because of the complex investment and tax implications surrounding RSUs, they are difficult to optimize and therefore, one should seek expert advice to help use them to achieve financial goals.
RSUs are a form of compensation that allow employees to share partial ownership of their employer via shares of common stock. The benefit is designed for long-term retention, and is therefore often awarded to employees deemed crucial to the future of the business. Typically, companies will not grant employees a specific number of shares each year. Rather, they will grant employees a certain dollar value in benefits, and that dollar value represents the number of shares they are granted on the grant date. This incentivizes future growth, retention, and improved employee performance.
RSUs are different than stock benefit counterpart, stock options. While options come in a couple of different forms, the idea is that one receives the “option” to purchase shares at a strike price, and then sell the stock at its fair market value (FMV). A majority of the time, when individuals exercise the stock by buying at the strike price, they will then sell at FMV and realize immediate value.
One key reason that companies are generally moving away from options is that if the stock’s FMV dips below the strike price, the options are worthless. While RSUs maintain some value even in down markets, options do not offer the same type of compensation to workers who would prefer to have something rather than nothing if their company stock price drops. Because of this, options would no longer be the long-term incentive they are designed to be. RSUs have slowly taken over this role in many companies, but they are complicated and require an intimate understanding of the investment and tax considerations to effectively manage them.
When one receives a substantial amount of company stock, it becomes easy to allow that one company’s ownership to account for a sizable portion of one’s liquid net worth. By overweighting one security (or even one asset class) in one’s portfolio, there is considerable investment risk because the performance of that one company dramatically affects one’s overall portfolio and therefore, one’s ability to achieve their financial goals. Instead, one should opt for effective diversification within their portfolio. Because of statistical risk, a good rule of thumb is to not allow ownership in one company to account for more than 10% of one’s total portfolio.By not overleveraging one position in one asset class, and instead diversifying across multiple securities in multiple asset classes, one could reduce risk on the portfolio and potentially increase the likelihood of achieving one’s financial goals. Rather than passively load up on one company’s stock, it’s paramount to seek expert opinion. This is especially true when one also considers taxes.
As with most forms of compensation, one must pay Uncle Sam. With some exceptions, taxes are not usually paid when stock is granted. Generally speaking, when stock is delivered, or “vested,” the shares are treated as ordinary income, and are therefore taxed according to one’s income tax bracket. The stock then becomes treated as a non-qualified asset. The vested shares may be sold or traded, and therefore incur a taxable capital gain or loss vis-à-vis the stock’s price on the vesting date. One should consult an accounting professional for details into their specific tax situation.
This is another reason proactive financial planning is exceedingly important. Depending on one’s financial goals, there may be ways to help mitigate some of these taxes. But, like most things in life, each situation is different and there is no formula that works for everyone. It requires intimate knowledge, attention to detail, and careful analysis of the situation to ultimately reach the optimal plan. Therefore, taking a proactive approach is a key component of achieving those goals.
Individuals who are busy with their daily lives may not have the time or information needed to make the most informed decisions regarding these benefits, and should consult with a qualified financial advisor. Unfortunately, RSU planning is often left an afterthought for so many intelligent, hardworking people, yet it could have massive payoff for all sorts of financial goals. Whether it’s saving for a child’s education, buying a home, retirement or estate planning, or just a separate “rainy day” fund, understanding the nuances surrounding RSUs is critical to maximizing the benefit and ultimately achieving one’s financial goals.
If you receive RSUs and have questions about your benefit, contact a qualified financial professional to discuss how to make them work toward your goals. After all, you earned it.