Congratulations, you’ve been granted Restricted Stock Units (RSUs) and they are about to vest. This can be an important financial opportunity for you and your family, but it also calls for important tax-management and investment decisions if you want to make the most of the benefit.
If you’re asking yourself, “What the heck is an RSU?” then you probably don’t have any, and don’t need to worry about them further. But for the record, RSUs are one way that companies can reward their employees in lieu of or in addition to a cash raise. As the name implies, it’s the gift of company stock … but with strings attached. The “gift” is really more like an IOU, because RSUs are typically subject to a vesting period or distribution schedule that defines when you’ll actually receive your shares. When they do vest according to their prescribed schedule, you’ll be subject to income taxes on the share value at that time. That’s whether you choose to use the proceeds to buy back more company stock, augment your personal investments, or splurge on a nifty new home entertainment system.
When we’re advising professionals about their vested RSUs, we usually suggest that they opt for a Same Day Sale, and that they invest the proceeds as part of their personal portfolio, allocating it according to the well-crafted plan they’ve described in their Investment Policy Statement.
Now let’s explain why this is our usual advice.
Taxing and Owning RSUs: Sell to Cover?
As your RSUs vest, you need to make decisions on how to pay for the taxes due and what to do with the vested stocks. Unlike non-qualified stock options that are taxed when you exercise your options, RSUs are taxed when they vest (which is an event you have no control over; they vest when they vest). At that time, you have three choices on how to pay the taxes and how long to continue holding the stock:
- Same Day Sale. This is the simplest. On the vesting date, you sell everything. After subtracting for tax withholding, you end up with net cash from the proceeds to invest or spend. All else being equal, this sort of “found money” offers a relatively painless way for you to invest more toward your life goals, so we typically suggest investing it rather than spending it.
- Sell to Cover. If you choose this option, the plan will sell just enough shares to cover the tax withholding. You keep the remaining shares, and you sell or gift them on your own, whenever you choose. This strategy entails heightened risk, as your human capital and personal capital remain conjoined. If your company falls on hard times, your career and your share values can take simultaneous dives. Just as it’s wise to take money off the proverbial table after it’s been “won,” it usually makes sense to diversify your personal and professional capital risks whenever possible.
- Cash Transfer. For this option, you come up with extra, out-of-pocket cash to cover the taxes due, and you keep all the shares that have vested. As with the Sell to Cover choice, you can sell or gift your vested shares whenever you want, with the same capital risk considerations involved.
An Illustration in Action
Let’s walk through an example and look at the math. Say you have 1,000 shares that are worth $50 per share on the vesting date, and that your tax rate is 40% for state and federal income taxes.
- Same Day Sale. You will pay $20,000 in state and federal taxes. You will own no vested shares and be left with $30,000 in cash to invest.
- Sell to Cover. You will pay $20,000 in taxes. You will own 600 vested shares currently valued at $30,000 and hold no cash to invest (until you sell those shares).
- Cash Transfer. You will pay $20,000 in taxes out of your own pocket. You will own 1,000 vested shares currently valued at $50,000 and hold no cash to invest.
Company Stock Considerations
Here are some additional questions to consider as you think through what to do with your vested RSUs:
Would you buy some of your company’s stock today? If you chose the #2 “Sell to Cover,” you are basically doing the same thing as if you chose a #1 “Same Day Sale,” and then immediately used the proceeds to buy 600 shares of your company stock on the open market. Ask yourself this: Would you have bought those shares outright if you had not received them as RSUs? If the answer is “probably not,” then reason should dictate that you may be better off investing the cash elsewhere, according to your overall investment plan.
Would you buy even more of your company’s stock today? Similarly, if you chose the #3 “Cash Transfer” approach, that’s the equivalent of buying 600 shares of company stock today with the after-tax proceeds from the vested RSU … plus adding $20,000 of your own money to buy 400 more.
Is there something magic about RSU stock? If you find your employer’s stock attractive, remember that you can buy as many shares as you’d like at any time on the open market. You don’t have to buy shares on the RSU vesting date or in the exact number prescribed by the event. Again, we recommend against letting the convenience or emotional attachment of vested RSUs lull you into buying more (or any) shares of your employer’s stock that you would not otherwise choose to hold.
Let Evidence-Based Investing Be Your Guide
Maybe you’re still not convinced about cashing out of that company stock. We understand. We really do. You’ve worked hard to contribute to your company’s growth, and it may feel as if you are giving up on more growth to come. You may also be emotionally attached to those shares, feeling that they represent your personal stake in the company’s future. It’s this sort of admirable, on-the-job loyalty that has probably contributed to your professional success to begin with.
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While we can empathize with these feelings, we feel it is our duty as an objective advisor to remind you that emotion-based investing is typically an ill-advised strategy for achieving your family’s highest financial interests. And while your career may be (should be) extremely important, your family’s overall wealth and well-being is important too.
In short, your personal wealth management deserves rational, evidence-based financial decision-making. But here is where it gets tricky: What is perfectly rational in your career decisions doesn’t necessarily translate to that which is rational for your personal wealth. Your career depends on your doing all you can to ensure that your company continues to thrive, so you can thrive along with it. Your personal wealth depends on your doing all that you can to wisely invest that which you already have earned, so that, come what may, you can always work because you want to – never because you have to.
We help successful professionals position their restricted stock options and other resources accordingly. The next step is yours. Let us know if we can help you determine the best positions for you and your RSUs.
Life is uncertain. The market is even more precarious. This means building wealth has no shortcuts. Success requires a solid investment approach, a long-term perspective, and discipline to stay the course. Instead of leaving your financial future to chance, you need to have a plan.
Cogent Strategic Wealth is here for you. We assess all areas of your financial life, using a retirement planner that won’t miss the details.
So, instead of worrying about your future, why not take positive steps to protect it? Set up a Cogent Conversation with us today. We’ll show you how to transform your hard work into durable wealth even through troubling markets.
With our years of experience, we know a disciplined investor looks beyond the concerns of today to the long-term growth potential of markets. Investors have had concerns and challenges in the past, and they know there will be concerns and challenges in the future that a comprehensive retirement planner will find. We are here for one reason: to help you reach your financial goals, come what may. Contact us today so we can help you, too.
The original article appeared in 2016.
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