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Restricted stock units – what are they and how do they work?

Restricted stock units – what are they and how do they work?

December 13, 2023

Basic conceptsA restricted stock unit (RSU) is a popular equity compensation structure that companies use to reward employees and incent you to stay with the company.

There are a few basics that are important to understand when talking about RSUs. First is the grant date. On grant date a company gives you a certain number of stock units. Those units are restricted because you could not sell them when they are granted. You can only sell after a certain restriction period or vesting schedule has been met. Many companies use a staggered vesting schedule over a period. For example, a four-year vesting schedule means you would own ¼ of the shares each year until you are fully vested. At vesting you become owner of the shares and are free to hold or sell them.


 

Example: Using our example of 100 shares, a stock price of $25/share, and a 4-year vesting schedule, let’s look at how this works.

On the grant date you are given 1,000 shares worth $25/share, or a paper bonus of $25,000. There is no tax consequence here, because you may leave the company before any of the shares vest, and your grant wouldn’t be worth anything.
After 1 year, a quarter of your shares vest. You are now own 250 shares. Congrats! But at what price do you own your shares? Whatever the price is on the vesting date. If your company has done well and the stock price has risen to $30/share at your first grant date, your first 250 shares are worth $7,500.

Now what?

There are two important concepts to think about after your shares vest. They are taxes and stock ownership.

First, taxes: On the day your shares vest you will be subject to income, social security and Medicare taxes. The $7,500 received in our example is much the same as getting a $7,500 paycheck from your company. To cover the taxes many companies deploy a mandatory withholding of shares. In our example rather than receiving 250 shares, the company may only deliver you 225 shares, selling 25 shares on your behalf to cover the applicable taxes.

Now that you own 225 shares of your company what should, and could you do with them? Owning the stock at this point is just the same as if you bought the shares with cash the day of the grant. From this point you can choose to hold it and enjoy potential growth and/or dividends. Or you can sell them and deploy the cash elsewhere.

Something to consider is how much concentration do you want to have in one company? There is something to be said about not having all your eggs in one basket. This is especially important when that “basket” also provides your paycheck. A question I like to ask clients is if you had the cash today would you buy your employer’s stock. If the answer is not a resounding yes, then maybe you should consider selling and redeploying those funds.

RSUs are becoming more popular. They can be a valuable part of your compensation plan and future wealth. It is important to know how they work and how to plan for them. If you have questions let’s chat!