Find yourself with restricted stock units (RSUs) as part of your compensation package? Congratulations! These equity awards have the potential to open many doors financially. To help you maximize the value of your restricted stock units, careful planning is needed to navigate the decisions soon to appear on your financial journey.
Financial planning for restricted stock units differs from the planning you should undertake for other stock options. Understanding the differences will help you maximize the value of your RSUs while ensuring you don’t fall for many of the common mistakes.
To help, we’ve developed four financial planning essentials to help you understand how these RSU equity awards can positively affect your financial plan.
1. Know Your Vesting Schedule
To have your RSUs delivered, you’ll have to meet the vesting requirements outlined in your grant agreement. Vesting simply means the process it takes to earn an asset; companies often enact vesting requirements to incentivize employees to stay with the company longer. Vesting schedules are often time-based, requiring you to work at the company for a certain amount of time before vesting can occur.
Here’s an example to help: You’re granted 3,000 RSUs after a stellar performance review. Your graded vesting schedule is for three years, and 1/3 of the grant vests each year. At the first anniversary of your grant date (and on the same date over the subsequent two years), 1,000 shares vest. Once each portion vests, you have the opportunity to sell the shares.
The type of vesting schedule outlined in the prior example is known as a graded vesting schedule (i.e. the vesting of the grant occurs in portions). Vesting schedules also come in another form known as the cliff vesting schedule. Under this kind of vesting schedule, 100% of the grant vests at once after you’ve completed a defined working period.
It’s also important to understand that a vesting schedule can be performance based, such as being linked to company-specific or stock market targets.
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Vesting and IPOs
At newly public companies, grants made before the initial public offering (IPO) may also require a liquidity event, such as the IPO itself, to occur before the shares vest. Once the liquidity event has arrived, the shares vest 180 days later.
One key item to note is that job termination is likely to stop vesting. The only exception is with special situations where vesting is still allowed to occur or may be accelerated (i.e. death, disability, or retirement). Be sure to review your grant agreement to understand these intricacies.
Once your RSUs vest, you’ll want to choose whether to keep them or sell them. If you need cash to meet personal expenses or big purchases like a vacation home, the shares can be an ideal source of funds.
Selling your RSUs has another added benefit: it allows you to diversify your portfolio. Company stock is usually the most risky asset where employee portfolio’s are overweight. For this reason, we believe it is rarely prudent to keep your RSUs once vesting has occurred.
If you find yourself regularly in possession of important confidential information about your company, you may want to consider adopting a Rule 10b5-1 trading plan to facilitate a planned sale of stock.
2. Plan Appropriately for Taxes
Without proper tax planning surrounding your restricted stock units, you risk a surprise tax bill come April. Here’s what you need to know to confidently navigate this tax journey.
First, tax planning is more straightforward for RSUs than it is for other stock options. With RSUs, you pay income taxes when the shares are delivered, which is usually at vesting.
The value of the stock at vesting will be reported on your W-2 in the year when the shares are delivered to you. Your company plan may withhold taxes, which includes federal income tax, state income tax, local income tax, Social Security, and Medicare taxes.
Yes, these taxes in aggregate can consume a large portion of the proceeds from selling your RSUs. This is especially true for those living in places where local tax rates can be as high as 4% (looking at you NYC!).
Some plans let you pay the withholding taxes by surrendering an equivalent value of shares. Share surrendering lets you not only avoid paying taxes in cash, but also helps you diversify your stock portfolio by using company shares instead of cash to meet your tax obligations.
Once you’ve moved past the initial price tag of your tax bill, it’s important to know you may not be out of the woods quite yet.
Tax Underpayments
Tax Underpayment Alert: RSUs are treated as supplemental income. Many companies withhold federal income taxes on RSUs at a flat rate of 22% (37% for amounts over $1 million). If your marginal federal income tax bracket is higher than 22% excluding RSUs, you’re most likely not withholding enough. You will need to either increase your withholding amount from each paycheck by adjusting your Form W-4 or proactively stash money in a tax set aside account whose sole purpose is to hold cash to cover the difference when you file a tax return the following April.
3. Retiring Soon? Check the Grant Agreement
If you plan to retire before vesting, check the terms of the plan or grant agreement. For qualified retirement as defined in the stock plan, the entire award may vest, or a pro rata portion may vest according to your service through the retirement date. This means that vesting will continue through the end of the year of separation (but not after), provided only a portion of the option that otherwise would have vested at the end of such year shall vest.
The answer to this question will affect your cash flow in retirement and any income-shifting strategies. You may be able to choose a retirement date that maximizes your entitlement to these awards.
4. If the Grant Agreement Allows, Designate a Beneficiary
Like any other asset you own, RSUs that vest upon your death become part of your estate when you die. Naming a beneficiary is one of the easiest ways to avoid probate. If you’re not familiar with probate, you could learn more about it from our previous blog, “Your Complete Guide to Estate Planning.”
Some RSU plans give you the ability to designate a beneficiary, especially if the plan also allows accelerated vesting or vesting to continue after death. Other plans may not explicitly allow or disallow beneficiary designations.
We encourage you to reach out to your Human Resources Department to understand if you can name a beneficiary. If allowed, don’t miss this step!
Continuing the Conversation
Hoping to understand even more how your restricted stock units can help you reach your financial goals? We are here to help!
Schedule a call with an Abacus advisor today to discuss your RSUs and how to best maximize their impact on your financial future.
