Top 5 Things to Look at with Restricted Stock Units (RSUs)

October 30, 2024

Restricted Stock Units (RSUs) are a common component of compensation packages at many tech and entertainment companies. While RSU’s can be an excellent way to build wealth, they come with complexities, particularly around taxation and how to incorporate them into a long term financial plan. Without proper strategies in place, RSUs can become more of a burden than a benefit. As a Certified Financial Planner (CFP) and CPA, these are the top five considerations I focus on when working with clients on their RSUs:

1. Understanding the Vesting Schedule

RSUs are not owned outright when granted; they come with a vesting schedule that determines when they become available to the employee. The vesting of the RSU’s triggers a taxable event, making it crucial to understand the timing. Common vesting schedules include:

• Cliff Vesting: Shares vest all at once after a specified period. A 1yr cliff is common whereby no shares vest in the first 12mo of employment and then a big chunk will vest once the 1yr mark is reached.
• Graded Vesting: Shares vest gradually over time (e.g., quarter or monthly). Typically this would happen after a 1yr cliff — but all plans can be different.

Knowing the vesting schedule helps in planning for taxes and liquidity need, ensuring that RSUs are incorporated into a broader financial strategy.

2. Ensuring Adequate Tax Withholding

When RSUs vest, they are taxed as ordinary income. The amount of taxable income is based on the fair market value of the shares on the vesting date multiplied by the number of shares that vest. Employers will withhold taxes on the vesting RSU income. By default, taxes are withheld at a 22% federal rate. State tax withholdings may also apply. But this level of withholding may not be sufficient for high-income earners. It’s important to ensure that withholdings are adequate to cover the tax liability and avoid surprises at tax time.

Considerations include:

• Adjusting Withholdings: Many employers let you increase the withholding rate higher than the default 22%. This is a great way to avoid large tax underwithholding and underpayment penalties.
• Estimated Tax Payments: In cases where RSU income is significant, quarterly estimated tax payments may be necessary to manage tax obligations and avoid penalties.

This proactive approach helps manage the tax burden and ensures that clients stay in compliance without unexpected year-end liabilities.

3. Timing of Sales

After RSUs vest, the decision to sell or hold shares should be made with careful consideration of financial goals, risk tolerance, and tax planning. Factors to consider include:

• Short-Term vs. Long-Term Gains: Holding shares for more than one year post-vesting allows any additional gains to be taxed at long-term capital gains rates, which are lower than short-term rates.
• Tax Loss Harvesting: If the share price decreases post-vesting then you may be able to sell the RSU’s and generate a tax deductible capital loss.
• Cash needs: Selling RSU’s immediately after they vest allows you to get the cash proceeds without incurring additional capital gains.

By strategically timing RSU sales, you can ensure your assets actively contribute to your financial goals.

4. Diversification

RSUs are directly tied to your employer’s stock, and while it can be tempting to hold onto them, having too much of your portfolio concentrated in a single stock—especially your employer’s—can increase financial risk. Diversification is key to managing this risk effectively.

Here’s how to approach it:

• Systematic Selling: Developing a plan to sell RSUs periodically can help reduce exposure to employer stock and spread risk across a more balanced portfolio.
• Re-allocation Strategy: Using the proceeds from RSU sales to invest in a diversified portfolio helps create a more stable and growth-oriented investment strategy.

By focusing on diversification, you can manage your risk more effectively and ensure that your financial future is not overly dependent on the performance of one company. Integrating RSUs into a broader investment plan allows for long-term growth while reducing potential volatility.

5. Long-Term Financial Planning and Goal Alignment

RSUs are one piece of a larger financial puzzle and should be integrated into a comprehensive plan that aligns with long-term objectives. Key areas of focus include:

• Retirement Planning: RSUs can be a powerful tool for building retirement wealth. Converting them into cash and investing proceeds into tax-advantaged accounts is one way to optimize long-term growth.
• Major Life Events: Planning for significant events like buying a home, funding education, or starting a business may involve using RSUs strategically to manage cash flow and minimize taxes.
• Charitable Giving: Donating appreciated RSU shares can offer tax benefits while supporting charitable goals, making it a win-win for those looking to give back.

Integrating RSUs into a broader financial strategy ensures that they contribute effectively to overall wealth-building efforts.

Final Thoughts

RSUs are a valuable component of many compensation packages, but they require careful planning to maximize their benefits. By focusing on the vesting schedule, ensuring adequate tax withholding, timing sales strategically, monitoring company performance, and aligning RSUs with long-term financial goals, individuals can make the most of these opportunities and mitigate potential risks.