Restricted Stock Units (RSUs) are a type of compensation that many employers in Silicon Valley offer their employees as an incentive to continue with the company for a given length of time. The RSUs “vest” after a predetermined number of years, at which time they’re assessed at fair market value, and become available for you, the employee, to sell or hold as you so choose.
RSUs can be confusing for a lot of people. The overwhelming sense that RSUs aren’t “real money” can push a lot of tech employees to ignore them for an extended period of time, or to avoid working them into their financial plan. Today, we’re going over the basics of how RSUs work, what you can do with them, and different tax pitfalls you should avoid. Let’s dive in!
How Do RSUs Work?
Your RSUs are part of your compensation package and will vest after a certain period of time. Usually, this is anywhere between 1-7 years, and sometimes a percentage of them will vest each subsequent year after the initial grant date. You can’t sell the shares until your RSUs vest.
When RSUs are part of your financial plan, it’s important to give them the same weight you’d give any other form of income. Unfortunately, many people don’t pay close attention to their RSUs because they seem overwhelming, or because they’re under the impression that they need to hold onto their vested RSUs for at least a year in order to receive favorable taxation on the profit that comes from their sale.
Watch this video to learn more about how RSUs work:
Embed this video: https://youtu.be/Vfoun7dxtF8
What To Do With Your RSUs
The truth is, you have two options when your RSUs vest:
- Hold onto shares hoping the price goes up. Ideally, if you plan to hold onto your vested RSUs, you’ll hold them for a year or longer in order to qualify for long term capital gains tax.
- Sell your RSUs as soon as they vest. Many people avoid this option because they’re worried that by selling right away, they’re going to get hit by unfavorable taxation. However, this isn’t the case.
How RSUs Are Taxed
In reality, when your RSUs initially vest, you’re already having those funds taxed as ordinary income whether you sell them or not. So, if you sell the same day, you’re only taxed once as opposed to being taxed initially and later on for capital gains associated with the sale of your stock.
Holding onto your RSUs for a year or more, you’re essentially putting all of your eggs in one basket – and then living in that basket. If something should happen to your organization, and you lose your job, you’re in a position where your ordinary income has taken a hit – and the stock you have in the company has also lost a lot of value.
Alternatively, if you hold your RSUs for a year or more and they grow significantly in value, you’ll still owe long-term capital gains taxes in addition to the initial income taxes you paid on the value of the shares when they vested.
Diversification should always be a priority, and by selling your RSUs the day they vest, you accomplish:
- Helping to diversify your portfolio.
- Avoiding additional taxation beyond ordinary income tax.
Keep in mind that, while companies typically sell a portion of your RSUs the day they vest to cover your ordinary income taxes, but they rarely withhold enough for high-income earners – so you’ll need to plan accordingly.
Don’t Ignore Your RSUs
Most tech employees aren’t 100% sure how RSUs work, so they just don’t touch them – which can cause an even bigger tax mess in the future. It can be helpful to have a plan in place before your RSUs vest to avoid frustration or stress when they do vest. We suggest you consider selling your RSUs the same day they vest to remove the emotions and guesswork.
Don’t wait to put a plan in place for your RSUs. Map out what you’d like to do with them when they vest, and how they fit into your long-term financial goals.