Restricted Stock Unit (RSUs) Strategy Guide
Many of the clients I help come from the tech industry and it really amazes me how many of them built up wealth and investments without really understanding how they work. Yes, living within their means played a huge part in their financial success, but so had investing in retirement accounts and receiving employer stock awards. Retirement accounts and investments receive much of the attention from other financial planners, so in this post, I want to focus on providing you a Restricted Stock Unit strategy guide. Most employers that offer stock in form of compensation have switched from Stock Options to Restricted Stock Units or RSU’s.
Here are the highlights of how RSU’s work:
- Grant Date: The date you were awarded RSUs
- Vesting Schedule: The rate and timing that you RSUs will be vested
- Vested: When shares vest, you become the owner of the equivalent of units that vested.
- How Taxes Work: You are taxed at the time your RSUs are vested at ordinary income tax rates. If you hold onto the shares, future growth or loss will be treated as Capital Gains/Losses
- Termination: At termination, you lose unvested RSUs unless your vesting schedule is accelerated at termination (common with workforce reduction packages).
Stock compensation can be very valuable to employees and the employer because having an owners’ interest in the company you work for can increase productivity and job satisfaction. Stock compensation is also a built-in investment plan for employees, which allows them to realize the potential of having assets that work for you. One threat that most employees often ignore is the real possibility that the stock may go down. A company’s stock can go down for many reasons, but here are just a few:
- a general market decline
- loss of competitive advantage
- product recalls
- products fading from relevancy.
This threat starts out small enough as you are new to the company, but over multiple years it is really easy to build up a significant amount of undiversified risk through your employer stock. What if you woke up the next day and because _____________ (fill in the blank) the stock dropped like a rock and is now only 25% of the value it was the previous day. Hopefully, this is just a dramatization of what can happen, but think about it, how sick would you feel? I always explain to my clients, we have a plan that doesn’t require us to hit home runs, the key is to stick to plan and not allow FOMO (fear of missing out) to lure you into taking more risk than is necessary to achieve their goals. The best way to reduce the risk of employer stock is through diversification. This doesn’t mean you can’t own any employer stock, but I have seen new clients with a net worth of $2 Million and $1.5 Million in employer stock, that’s clearly too much. A maximum limit that I would recommend my clients is to stay within is 10%. Still, that would be only if they have a high threshold for risk. Below are a few RSU strategies you may be able to use based on the shares of employer stock you’ve accumulated. These are not recommendations, as I analyze and work with my clients in great depth to build more precise recommendations based on their personal scenarios. One value I can offer you is an investor profile analysis. This analysis will help you understand your risk versus reward behavior, which can help you better construct and navigate building your investment portfolio.
Sell new shares that vest as soon as allowable. Your shares are taxed at vesting so if you are able to sell them before any major price movements, there should be negligible tax consequences.
The market has been pretty hot across the board, so it’s likely that your accumulated employer stock has gone up in value and would cause gains to be taxable at capital gains rates. Depending on your threshold for paying taxes, you may be able to sell all or you may want to devise a systematic plan to gradually reduce your exposure to your employer’s stock.
You may also have some shares that have fallen in value while others have risen. You can use the shares with losses to offset the shares with gain from a tax perspective.
Tax Rate Arbitrage
Capital gains tax is treated at a lower tax rate than where most people land for ordinary income tax brackets. There are three rates that apply to Capital Gains Tax, 0%, 15%, and 20%. However, there is also an additional Medicare surtax of 0.9% to be aware of. If you fall into a higher tax bracket than where you would for capital gains tax then, there is an opportunity for tax rate arbitrage. Use the proceeds from the sale of your stock to defer income into one of the following: Traditional IRA, Traditional 401(k), or HSA. You will want to verify you’re eligible to make deductible contributions to either of the previously mentioned accounts and understand that funds added to them have their own unique set of rules (mainly withdrawal penalties if not used for retirement age 59.5 or older or health care in the case of the HSA). Due to withdrawal rules for retirement accounts, these are significantly more appealing as you are closer to retirement age. Since there is the arbitrage effect though, you wouldn’t need to move over all of the proceeds. Much of your proceeds are not taxable because you already have a basis for paying taxes when you were first awarded your shares and you receive a bigger punch from the income deferral.
Here are the current tax rates for RSUs when they vest as ordinary income.
|Ordinary Income Rate||Single Filing (Unmarried)||Married Filing Jointly|
Here are the current tax rates for old shares that you’ve accumulated when they become long-term gains.
|Long-Term Capital Gains Rate||Single Filing (Unmarried)||Married Filing Jointly|
|0%||Up to $38,600||Up to $77,200|
|20%||Over $425,800||Over $479,000|
Buy Put Options
If you are unable to sell all of your shares or simply don’t want to, you can buy put options on your employer stock to protect from catastrophic losses. Buying a put option gives you the right to sell your stock at an agreed upon amount before a particular date. This helps minimize the downside, but the cost of buying the put option reduces the upside by the cost paid.
Employer stock rewards are an extremely valuable part of your overall compensation, but if not managed as a part of a strategic plan can be extremely stressful to navigate. Having an RSU strategy in place will allow you to separate emotion from your decision-making process and allow you to make clearer decisions that align with your overall goals and risk tolerance. Feel free to request a complimentary consultation with me to see if we may be a good fit to work together to address your RSU strategy or a full comprehensive plan.