Congratulations, you’re either in a position where your company has granted you Restricted Stock Units (RSUs) or you’ve recently accepted an offer that includes them in your compensation package. Restricted stock units are a terrific benefit. When planned for correctly they can be a major catalyst propelling you towards your financial goals.
Creating Your Plan
The first step in formulating your plan is to confirm that you were in fact granted RSUs… there are several different types of equity compensation, each with their own unique characteristics and tax consequences. So, gather up your offer letter, grant document and employers stock plan and take some time to confirm the type of equity comp you are receiving. It’s also important to highlight and keep track of any key dates (grant date, vest date, etc.)
Now that you’ve confirmed that they are RSUs it’s time to start planning. There are no tax implications with RSUs until vest date. Once they vest, the price of your company’s stock is used to calculate your additional income. This means they will be taxed at your ordinary income rate. To better understand the basics of restricted stock units check out this blog.
There are no tax benefits to holding on to your RSUs. However, that doesn’t necessarily mean that you shouldn’t. The correct answer to almost every financial planning questions is it depends. A holistic picture of your financial and life circumstances can help you understand if you are in a position to take the additional risk associated with building a concentrated position in your company’s stock.
While selling the shares immediately upon vest is generally the best approach, we are all human. Emotions always impact our decisions and thought processes. While selling may make sense for you, it is easier said than done. You may love your company and feel like selling the shares is somehow disloyal or against team spirit. There is also some bias because (of course) you believe in your team, management and company’s ability to perform. I get it! The truth is the market doesn’t really care and doesn’t always agree. Creating an over concentrated position in your company’s stock can expose you to wild fluctuations in your net worth and potentially underperform a more diversified portfolio.
As financial planners our job is to educate you and provide you with the options available to you and steer you clear of any truly financially disastrous decisions. Each person’s sentiment and risk tolerance is different and so the plan that works best for one person isn’t necessarily the best for another. Given that, the options available to you are:
Admittedly, this is the most conservative approach when handling your RSUs. Statistically, it is also the best on average approach to take. That is not to say that there aren’t situations when this isn’t the best approach: ask anyone who has worked at Apple or Amazon over the past year or so. Look at it this way, if someone handed you $40,000 right now, would you invest it in your company’s stock? If the answer is no, you already know what to do. If the answer is yes, may the force be with you.
Diversified portfolios on average tend to outperform single stock positions (not what you Game Stop experts want to hear). Investing your money across different asset classes and geographic regions will keep you diversified in your long-term allocation and is easier and cheaper than ever with the rise of ETFs.
Your other financial goals are also important to consider when making this decision. Are you planning on buying a house soon? Thinking about getting married? Do you have any debt looming over your head that is keeping you up at night? Equity compensation is compensation and should be viewed through that lens if you have an immediate need for the cash or other financial obligations to factor in.
Keep Them All
This is the riskiest approach to take. When your restricted stock units vest your company will withhold a certain number of shares to cover taxes. (Side note – the number of shares withheld is generally enough to cover 22%, unless your income was $1MM+ on the year. Beware of the tax monster… you may owe a bit more come tax time depending on your marginal tax rate).
The truth is, concentration like this can create life-changing wealth if your company’s stock goes directly to the moon. Given all of the headlines around Amazon, Netflix and Apple you would be inclined to believe that this is in fact the best route. The answer to this is like most others when it comes to financial planning – it depends.
Financial Planning Building Blocks
If you’re willing to make this bet, there are a few financial planning basics you should have squared away first:
- Get your emergency fund in order. This is typically 3-6 months in cash that could cover your behind in case things go awry.
- All your other savings in place and in a position that will allow you to retire when you are planning to.
- You understand that if the stock drops you will not only lose money with the drop in price, but you also risk the ability of not being able to have enough to sell to cover any additional tax liabilities.
- You are fine with losing every single dollar in your company’s stock in the event things went really, really sour.
As a financial planner my goal isn’t to stomp on all your dreams and aspirations. My goal is to present you with the risks associated with each option to help you choose your path with all the information you need to confidently do so. It’s statistically unlikely that your company’s stock will be the next Netflix, but that doesn’t mean it can’t happen!
Cover your taxes and keep the rest
Companies are required to withhold 22% based on IRS rules regarding supplemental income, unless your income is above $1MM. If your income is above $1MM 37% will be withheld. This means that you will most likely owe additional taxes if you are receiving RSUs. To avoid losing money on the RSUs, you can sell enough to cover any additional tax you owe. This removes the risk in the third bullet point above by ensuring that you have enough to pay your taxes no matter what happens. While still a risky approach, it is less risky than keeping all of them and holding on for dear life.
The “I understand what you’re saying but can’t bring myself to sell all of them” approach
Like I said earlier, I understand the emotional component that comes along with selling your company stock. This is the approach to take when you understand all of the facts and strategies, but are still unwilling to sell all the shares on vest date. We’ve gotten this far, the wheels are turning and you’re actually understanding what I’m saying. Compromise is OK. If you already have a highly concentrated position selling off enough to get your exposure to 10% of your portfolio may be too much to digest at one time. It is better to take some concentration off the board than none at all! Setting up a systematized plan to sell and further diversify your investments over a time period that works for you is acceptable.
I hope this helps you decide on and stick to your strategy with your restricted stock units!
Disclaimer: The information on this site is not intended as tax, accounting or legal advice, as an offer or solicitation of an offer to buy or sell, or as an endorsement of any company, security, fund, or other securities or non-securities offering. This information should not be relied upon as the sole factor in an investment making decision. This content is provided “AS IS” and without warranties of any kind either express or implied. To the fullest extent permissible pursuant to applicable laws, Hereford Financial disclaims all warranties, express or implied, including, but not limited to, implied warranties of merchantability, non-infringement, and suitability for a particular purpose.