If you work for a big public company, you may receive some nice retirement benefits not provided at a small business. Not only do you receive great healthcare, a retirement plan with matching and other profit-sharing availability, but you also typically receive some type of stock options. There are various plans including Employee Stock Purchase Plans (ESPP) where you are able to buy stocks at discount, usually at least 15%. There are also Incentive Stock Options (ISO) or Non-Qualified Options (NSO) that provide the employees with the ability to buy stock at a specific discounted price in the future. The ones we run across more often and had the most questions about lately are Restricted Stock Units or (RSUs). These are a way for an employer to grant company shares to an employee at a certain point in the future when shares vest. RSUs are particularly popular now with tech companies and can be extremely lucrative for the employee.
A lot of times we get asked, “How will I be taxed” or “What is the best strategy for selling them?” Clients also wonder, “How much is too much and should I keep some if I believe in the company?” These are all valid questions and specific answers may vary depending upon your overall financial plan. In general, though, RSUs are taxed when you receive the shares. The market value of the shares at vesting is included as taxable income.
For example, you are granted 1,000 shares at $20. When the shares vest in 3 years, they are now worth $40. You now would include $40,000 as ordinary income for the year ($40 x 1,000 shares). You could hold on to those shares if you would like and if the stock appreciated more in the future when you sold, you would then pay capital gains on price above market value when they were granted.
Usually, the company will withhold a portion for certain taxes, and you can have them withhold an additional amount to pay for personal income taxes. If they will not do that, you need to take this into consideration when filing taxes and realize that your bracket might move up for the year and it might be worth planning for some charitable giving or other tax minimization strategies. The tax when the shares are sold is similar to other stock transactions and the employee would receive preferential treatment of long-term capital gains as long as they held stock for at least a year after the grant.
RSUs have benefits to other stock options which could potentially lose value due to stock price. RSUs prove more valuable but do provide certain “restrictions” with their vesting schedule and other incentive bonuses structures. They are a great way for employers to retain their employees not only at the company for extended period, but also for more productivity. The vested period and amount can be based on the time with company, performance based, or even a combination of both. They can also be vested gradually throughout the year or a few years or cliff based where it’s all provided at once.
A common rule of thumb is that you do not want more that 10% of your portfolio in one single stock for diversification purposes, but especially for the reason that a significant portion of your wealth is tied up in your employer. If something were to happen to the company, you may not only lose your job, but also a significant portion of investable assets derailing your retirement plan. We understand employees may value the company they work for and believe in its continued growth, or there might be some emotional connection to the stock. After all, you didn’t pay anything for it in the first place. However, it is still important to have a financial plan and have a large portion reallocated into a diversified portfolio. Depending on circumstances this could help you pay down debts, build up emergency reserves, possibly pay down additional amounts towards a mortgage and then allocate a diversified portfolio to help reach retirement income goals. There are a lot of considerations to the timing and amount of RSUs, so it would be beneficial to have a discussion both with a team of financial advisors as well as CPA.
Matthews Barnett, CFP®, ChFC®, CLU®
Financial Planning Specialist