A restricted stock unit (RSU) is a form of common stock that a company promises to deliver to an employee at a future date, depending on various vesting and performance conditions. Restricted stock units are not received until these restrictions are over or conditions are met. An employer will promise to give an employee stock under certain conditions, such as meeting particular work goals or being at the company for a particular amount of time. Although detailed long-term financial plans may be best talked through with a professional financial advisor, knowing how RSUs work could help you understand a bit more about whether a job offer is right for you, and where the compensation package fits within your overall personal money goals.
When Do Employees Receive RSUs?
When an RSU is granted to an employee, a future date is set to signify the restriction (either a minimum number of years at a company, hitting a particular milestone, etc.). The kind of vesting schedule is also determined at that time.
There are a few different types of vesting schedules. Cliff vesting means that all of the granted shares are delivered at the same time. Graded vesting means that the employee vests smaller parts of the granted shares over regular intervals. Hybrid vesting involves a combination of those two.
RSUs will have an estimated value at the time of the grant, but the ultimate value to the employee depends on the fair market value at the time they vest.
Advantages of Restricted Stock Units (RSUs)
There are various advantages for both companies and employees to use RSUs. Many companies will use them because they expect to reach their valuation in the future. They can attract employees and and offer this additional incentive. Companies may also see this as a way to save money, because they are effectively offering compensation to employees without technically paying them up front.
For employees, the benefit is mainly that an employer is offering a form of equity-based compensation via stock shares. Once vested, the employee will own the stock shares at the current market value and depending on the value of the stock at this time, employee earnings could be higher than originally expected.
Disadvantages of Restricted Stock Units (RSUs)
Disadvantages for RSUs largely involve the unknowns. Companies cannot be certain that their stock will increase in value enough to sufficiently reward employees at a later date. Because their price is determined when the stock becomes vested, it’s hard to know their value in the future when the company creates its RSU plan.
This is also a disadvantage for employees, because they may not receive as much of a value as they anticipate. Also because of the time restriction, if an employee wants to fully vest they will have to stay at the company for the whole period, which can create a dilemma if the employee wishes to leave the company early for whatever reason.
How Are RSUs Taxed?
Taxes on RSUs apply when the shares are delivered – at the time of vesting. They require you to pay ordinary income tax on their market value when the shares are delivered to you (usually as soon as they vest), even if you do not sell them at that time. This includes federal, state and local taxes. Sometimes companies allow employees to sell a portion of the vested shares in order to cover the amount in taxes.
Following that, the employee can choose between holding the rest of the shares to sell later, or selling them right away. Selling the shares of course means paying any capital gains taxes on any appreciation, or increase in value between the selling price and the fair market value when the person vested.
Restricted Stock vs. Stock Options
An RSU is type of restricted stock, which falls under the larger umbrella of equity-based compensation and can be a type of employee stock ownership plan (ESOP). An RSU is different from an restricted stock award (RSA), which is another type of restricted stock. RSA shares are technically “owned” by the employee on the grant date. By comparison, an RSU is a promise by the employer to deliver on a future date.
Restricted stocks in general are very different from stock options, because of how ownership relates to the timeline over which an employee becomes an owner of the stock. Restricted stock allows employees to own the shares beginning on the day they’re issued. Restrictions apply because employees need to earn the stock. Restrictions include time (the vesting schedule) and also hitting particular performance milestones (such as a minimum tenure or promotion), to name a few.
Stock options, on the other hand, give employees the right to buy a set number shares at a fixed price, so an employee doesn’t own the shares until they buy them. Stock options can either be non-qualified stock options (NSOs) and incentive stock options (ISOs). When it comes to ISOs, employees usually don’t pay taxes until they sell shares. With NSOs, employees must pay taxes both when they purchase and sell their shares.
Bottom Line
A restricted stock unit (RSU) is a form of employee stock that may be included in a compensation package. Understanding how they work, when they vest and how they’re taxed may support you in deciding to offer one to your employees, or decide on a job compensation package if you’re a potential employee. In the short term, an RSU can be one possible portion of building a diversified portfolio that sets you up for your long-term financial goals, including retirement.
Tips for Maximizing Your Paycheck for the Future
- Figure out how much you’ll need to save in order to retire comfortably. An easy way to get ahead on saving for retirement is by taking advantage of employer 401(k) matching.
- Work with a financial advisor. Investing in a little expert advice now can help you a lot much further down the line. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool can connect you with up to three advisors in just five minutes. If you’re ready to speak to a professional who may be able to support you in achieving your financial goals, get started now.
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