Restricted Stock Unit’s (also known as RSU’s) are a form of Equity Compensation that your company may offer you to reward and retain you. Your company awards you shares and after you meet certain requirements, they will become yours.
Before we dive in deeper, let’s start of with the basics by defining a few different terms:
Grant Date
The date in which you have been granted (awarded) your company stock.
Vesting schedule
It’s the schedule in which unvested shares will be lifted of any restrictions and completely become yours.
Vested shares
This means you now have full ownership of the shares you were granted!
Un-vested Shares
These are shares that have been granted to you, but are not currently under your ownership and may have to meet certain requirements and/or vesting schedule for your full control.
Cost Basis
This is the original price of which the stock (or asset) was acquired for. You’ll need this for certain tax purposes.
Okay, let’s jump into everything you need to know about your RSU’s.
How do RSU’s work?
As mentioned, Restricted Stock Unit’s are a form of compensation from your employer in which they award you company shares. They can be awarded for many reasons including a service milestone, a certain employment position, or could be used as a tool to incentivize certain outside candidates.
Companies offer their employees RSU’s for many purposes, including the following:
- Allow you to participate in ownership of the company (and potential GROWTH).
- Align your work and vision with your employers’ goals and vision.
- Reduce need for company to pay only in cash (maybe they need this cash for investment elsewhere).
Let’s look at an example:
Congratulations, you just received a promotion in your company. You’ve received a salary increase as well as the following RSU’s:
Award Date: 5/5/2024
RSU’s awarded: 1000 shares.
Vesting Period:
5/5/2025 = 250 shares
5/5/2026 = 250 Shares
5/5/2027 = 250 Shares
5/5/2028 = 250 shares
As you can see in this example, 250 shares vest each year following the award date. In simpler terms, on 5/5 of every year, you will have full control of 250 shares of your companies stock.
Note. If you were to leave your employer before 5/5/2028, you would leave unvested shares.
Example
You decide to quit your job on 2/1/2027. Only 500 of your shares have vested and are in your control. The other 500 shares will be returned to your company with no benefit to you.
Something else to note here is the Vesting schedule. There are 3 main types of Vesting schedules:
Graded Vesting Schedule
This is where your stock awards vest gradually, building up to 100% vested. If you go back to the example above, you will see the Graded vesting schedule (25% or 250 shares per year for 4 years until 100% of the shares vest).
Cliff Vesting Schedule
This is where all shares vest at once after a certain time period has elapsed (Example. 100% of shares vest in 4 years after the Grant Date).
Immediate Vesting
The name speaks for itself. All shares are vested immediately upon receiving the Grant or Award.
Let’s move on to how these awards are taxed.
Tax Liability of RSU’s
Like most compensation, RSU’s also have a tax liability that is attached to them. When you get awarded RSU’s, there is no tax implication because the shares aren’t in your control yet. However, as your RSU’s vest, they will be taxed on the day they vest as ordinary income.
Let’s go back to our example above and let’s say our stock price is currently at $10.
On 5/5/2025, 250 shares of your stock award will vest. You will receive $2,500 worth of shares (250 shares x $10 share price). $2,500 will be added to your ordinary income.
Something to note here. Depending on the RSU plan, some companies may offer to “withhold shares” to pay for your taxes. In this case, they will withhold some shares at vesting, to sell and pay your withholding taxes.
Example. Your 250 shares vets on 5/5/2025. Your company withholds 100 shares to pay for your taxes and you receive 150 shares. Good idea to check this with your company to see if they are doing this or not, to make sure you don’t get a surprise tax bill when you go to file your taxes the following year.
Long Term Vs. Short Term Capital Gains
The vesting of your shares aren’t the only time that you may be potentially taxed on your RSU’s. Once your RSU’s vest, you will follow Capital Gains tax rules:
Short Term Capital Gain/Loss: If you hold the stock for less than a year (after the shares vest) and decide to sell, you will be taxed at a short-term gain or loss.
Long Term Capital Gain/Loss: If you hold the stock for a year or longer (after the shares vest) and decide to sell, you will be taxed at long-term gain or loss.
Now what? Sell or Hold
Once the shares are fully vested and in your possession, it’s up to you as to what you do with your shares. You have 3 options:
Sell – Sell your shares and cash out.
Hold – Hold onto your shares and participate in the advance or decline in stock price.
Do nothing – See above… (You’ve by default choses to hold).
There’s reasons why you would choose one of these strategies and the three main things to consider when making a decision are:
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- Your Goals
- Your risk tolerance
- The taxes
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These 3 elements should help you determine what decision you make when your RSU’s vest.
Here’s a few examples of how you may think this through or may be why you decide on what’s best for you:
- Maybe you hold because you think the stock will appreciate.
- Maybe you hold because you want your efforts at your job to play a role in the stock price.
- Maybe you sell because you don’t believe in your company in the short term.
- Maybe you sell because you have needs for the cash.
- Maybe you sell because you are too concentrated in 1 stock.
The Bottom Line
Restricted Stock Units are a great type of Equity Compensation that a company can provide to you as it doesn’t require upfront funding but allows the employee to participate in the company’s success. When you understand how they work, you can utilize RSU’s to help you build wealth and achieve your long-term financial goals.