You are probably pretty familiar with many of the standard offers in a job compensation package. When receiving an offer letter from a potential new employer, employees could be presented with a salary figure, paid vacation and sick day allowances, some type of health insurance, and, possibly, a retirement plan.
There may also be more unusual employment perks in the offer, such as the right to a creative sabbatical or tuition reimbursement.
Another benefit you could encounter is the opportunity to invest in company stock. Whether you’re a total investment newbie or someone who recites stock market terms in your sleep, the option to own some of your company’s stock could be an exciting way to diversify your portfolio and help you reach your financial goals.
There is some important background information employees should know before choosing whether to invest in their company’s stock. The language surrounding this particular job benefit might be confusing and you may be unsure if your company’s available stock is favorable compared to the larger market.
The first thing that could prove helpful is to gain a basic understanding of the two types of company stock benefits you could receive: employee stock options (ESOs) or restricted stock units (RSUs).
ESOs vs. RSUs
When a company offers employee stock options (ESOs) in a compensation package, it is essentially granting an employee the opportunity to purchase a certain amount of its stock at a predetermined price within a specific period of time.
Note that if you are granted employee stock options, you are absolutely not required to purchase company stock—it is simply an option that is made available to you should you be interested.
When determining whether you’d like to take advantage of your employee stock options, it might be helpful to consider the amount of time it will take for your stock options to vest.
Often, companies do not allow their employees to purchase company stock until that employee has proven their commitment to the company for a specific period of time. So, if you accept a job knowing that it is just a temporary position for you, you might not be able to take advantage of your company’s employee stock options anyway.
It is also important to consider the stability and value of your company’s stock relative to the wider market.
If you think that your company’s stock will increase in value over time, it will likely make sense that you exercise those options to take advantage of the appreciation.
However, if you think that your company’s stock will decrease in value over time, it might be a good idea to either exercise and quickly sell the shares before they decrease in value or hold off on exercising the options all together.
Companies might also offer their new employees restricted stock units as an alternative to ESOs. If you have been offered RSUs as part of your compensation package but are unsure about how RSUs work, this article will hopefully help you understand this unique financial benefit and it will outline the different decisions an employee could make regarding their RSUs.
What Are RSUs?
Restricted stock units are a type of compensation offered to employees in the form of company stock. RSUs are not technically stock, though; they are a specific amount of promised stock shares that will be awarded to an employee at a future date, or across many future dates.
Restricted stock units could be conceptualized as financial incentives for employees, like a bonus, since promised stock shares are awarded to employees only when an employee completes specific tasks or achieves significant work milestones or anniversaries.
Know the Dates: Grant and Vesting
In the case of RSU stock, it might be wise to take note of two important dates: the grant date and the vesting date. A grant date refers to the exact day that a company pledges to grant an employee company stock.
Employees don’t own granted company stock starting on the grant date; rather, they must wait for the stock shares to vest before claiming full ownership and deciding to sell, hold, or diversify stock earnings. The vesting date refers to the exact day that the promised company stock shares vest.
As previously described, RSUs do not technically belong to the employee until they are vested. The promised shares are distributed according to a vesting schedule that is determined by the employer. Factors such as employment length and specific job performance goals can affect a vesting schedule.
The employer may want to incentivize a long-term commitment to the company and thus tailor the RSU vesting schedule according to time. In other words, RSUs would only vest after an employee has pledged their time and hard work to the company for a certain number of years, or the vested percentage of total RSUs could increase over time.
If there are tangible milestones that the employee must achieve, the employer could also organize the vesting schedule around those specific accomplishments.
Typically, the vesting schedule of RSU stock will be categorized as either a cliff schedule or a graded schedule. A cliff schedule means that 100% of the RSUs will be vested at the same time. For example, if you are given 4,000 RSUs at the beginning of your job, on a cliff vesting schedule you would receive all 4,000 on one date.
However, if you are on a graded vesting schedule, you would only receive a portion of those 4,000 RSUs at a time. For example, you could receive
25% of your RSUs once you’ve hit your two-year company anniversary, 25% more after five years at the company, 25% more after seven years, and the final 25% after 10 years.
Alternatively, your graded vesting schedule might include varying intervals between vesting dates. For example, you could receive 25% of your 4,000 total RSUs after three years at the company, and then the remainder of your shares (3,000) could vest every month over the next three years at 100 per month.
It is crucial to note that if an employee leaves their position at the company before their RSU shares vest, they generally forfeit the right to collect on the remaining restricted stock units.
On a graded vesting schedule, an employee could keep the amount of RSUs already vested, but would forfeit the leftover shares. If that same employee is on a cliff vesting schedule and their shares have not yet vested, then they no longer have the right to their restricted stock units.
There are a few exceptions to this rule. In the cases of death, disability, or retirement, a person’s RSU vesting schedule can sometimes continue as is or even accelerate.
Of course, all of this depends upon the employee’s original RSU plan and grant agreement, as determined by the employer. If you find yourself in applicable extenuating circumstances, it might be a good idea to check in with your company to see what will happen to your RSU shares when you leave.
The biggest difference between restricted stock units and employee stock options lies in the way that RSUs are taxed. While ESOs are taxed the moment you decide to exercise your options, RSU taxation happens at the time of vesting. Essentially, restricted stock units are treated as supplemental income.
As soon as your RSUs become vested, your employer is required to withhold taxes on them, similar to how they withhold taxes on your income during every pay period. The shares are even added to your W2, meaning that you are required to pay normal payroll taxes, such as Social Security and Medicare.
It’s possible that your employer might withhold a smaller percentage on your RSU stock than what they withhold on your wages. What’s more, this taxation is only at the federal level and doesn’t account for any state taxes. What does this mean for you? In some cases, you could end up underpaying on your taxes when your RSUs finally vest.
Since vested RSUs are considered supplemental income, they could bump you up to a higher income tax bracket and make you subject to higher taxes. Or, your company could not withhold enough money at the time of vesting, causing you to owe money to the IRS.
Thus, it might be beneficial to plan ahead and come up with a strategy to manage the consequences of your RSU taxation. Talking to a tax professional as soon as your RSU shares vest might be a good strategy to help anticipate any future complications and set yourself up for success come tax season.
How to Handle RSUs
Once your company stock shares vest, you are faced with an important decision: sell or hold your shares. There are advantages to both options, depending on your individual financial profile.
Selling your vested RSU shares might help you avoid the common pitfalls of stock concentration.
A concentrated stock position occurs when you invest a substantial portion of your assets in one specific investment or sector, instead of spreading out your investments and diversifying your portfolio.
Even if you are confident in the growth of your company, the stock market can be very unpredictable and if you hold a large chunk of your assets in one place, there is always a risk that you could lose a lot in the event of a sudden downturn.
There is a double sense of risk when concentration occurs with RSU stock, since both your regular income and your stock are dependent on the success of the same company.
If, for some reason, you lose your job and your company’s stock starts to depreciate at the same time, you could find yourself in a tight spot.
Thus, selling your vested RSU shares and using the cash to invest elsewhere in a more diversified fashion will help minimize your overall risk.
Another option is to sell your vested RSU shares and keep the cash proceeds.. This might be a good choice if you have a financial goal that requires a large sum of money right away, like a car or house down payment, or maybe you’d like to pay off a big chunk of debt.
Holding onto your vested RSU shares might be a good strategy if you believe that your company’s stock value will increase, especially in the short term.
By holding out for a better price in the future, you might, potentially, receive higher proceeds than if you sold your shares immediately at the time of vesting.
When it comes to investing, there is no one-size-fits-all advice. It’s important to consider your unique financial needs when deciding what to do with your RSU stock.
Your specific financial goals, the amount of debt you may hold, the other types of investments you might be making, are all factors to consider when weighing the pros and cons of selling or holding your RSU shares.
If you’re still unsure about what to do with your vested RSUs, you might consider seeking out specialized advice by speaking with a SoFi Financial Planner.
When you work with SoFi Invest you have access to complimentary financial planning. The SoFi team can help you make the most of your restricted stock units.
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