What’s the right time to sell Restricted Stock Units (RSUs)?
Minnesota has a lot of large publicly traded employers. United Health, Target, Best Buy, Medtronic, US Bank, General Mills, are some of the biggest. Typically, these companies will use other forms of compensation to attract and retain employees. Restricted Stock Units (RSUs) are one of the most common. In the most basic sense, an RSU is just a promise from the employer to give you, the employee, some company stock in the future. To be given the stock you need to stick around at your job long enough for these RSUs to vest. This is laid out in the vesting schedule.
Order of Operations – What happens when your RSU’s Vest?
Every RSU you receive will have a vesting schedule. A vesting schedule simply outlines when you are eligible to receive the stock. A common vesting schedule will have a certain amount of the RSU vesting each year, e.g., 25% every year for 4 years. There is also RSUs that vest all at once, known as “cliff vesting”, which simply means you are eligible to receive 100% of the stock after a certain time period. For example, a 3-year cliff vest means you receive the full number of shares after 3 years.
This vesting period is important because of the tax consequences. Upon vesting, you are taxed on the value of the RSUs. This tax is subject to ordinary income tax rates as well as both Social Security and Medicare tax. The income is reported on your W2 in the year of vest and withholdings are, generally, taken out at the time of vesting. In many scenarios, the withholding is done through a reduction in the number of shares you are due to receive. An example of this, if you are expecting 100 shares upon vesting but only receive 90, it’s likely due to tax withholding. If you are a highly compensated employee, the withholdings will likely not be enough to cover the actual taxes due as your marginal tax bracket is may be higher than the statutory withholdings requirements. In the year you have substantial RSUs vesting, it might be a good to prepare a tax projection before the end of the year to determine the how much tax you should expect to owe in April. This is also why you should work with a financial advisor who not only prepares your tax return but also takes the time to perform necessary tax planning.
You’ve received your Company Stock, Now What?
Its important to note that once you’ve received your vested shares that it is really just the same as if you had received a cash bonus and subsequently bought your company stock with that money. So now, the question is, “Should you hold onto them or sell them?”
This, like all things financial, depends on your goals, circumstances, and overall financial plan. In general, however, you should consider selling them as soon as you receive them. This all assumes you are not in a blackout period, in which your employer restricts when you can sell company stock. This is typically done right before a big news event, such as an earnings release, although not all companies do this, or it might depend on your level within the company.
Think of RSU’s as a form of additional compensation. Similar to a bonus, you earned an extra lump sum of pay as a reward for sticking around with your employer. The only difference is that instead of cash, you are receiving shares in your employer’s stock. So, there is just one extra step you need to take to convert the shares to cash (by selling).
The reason I am suggesting an immediate sale is entirely due to the way RSU’s are taxed when they vest and then again when you sell the shares.
First, as I mentioned, previously, you are taxed when then vest not when you sell the shares of stock. Therefore, even if you don’t sell your shares you are still paying the tax at ordinary income tax rates.
Second, once you sell the shares you will either have a capital gain or a capital loss depending on how the stock performs before you sell it. This is either a short-term capital gain if held less than a year or a long-term capital gain if held for a year or more. Therefore, if you sell your stock right after vesting the capital gain/loss will be minimal.
Since you are already paying the tax when the shares vest there is no additional tax benefit to continuing to hold the shares. In fact, you could even end up paying tax on value you never actually receive. Let’s consider the following example:
RSUs Vested: 1,000 shares
Stock Price: $100/share
Value of Shares: $100,000
Marginal Tax Rate: 32%
In this example your RSUs vest and you receive stock worth $100,000 (in reality it will be less due to some shares being sold for withholding). No matter what you are going to owe approx. $32,000 in Federal Tax, $9,850 in Minnesota state tax (9.85%), and $7,650 in Social Security and Medicare Tax (7.65%) for an effective tax rate on your RSU of 49.5% (This does not include any shadow taxes, AMT, NIIT, or the Medicare Surcharge). Now let’s say your shares go down in value by 20% to $80,000. If you sell now, you still owe the tax on the $100,000 of initial value but since you are selling your shares at a lower price your effective tax rate increases to almost 62%!
Still not convinced. Let’s say instead of giving you RSU’s, your employer, gives you $100,000 cash bonus. You would owe the same tax as the above example leaving you with $50,500 after tax. Would you take that bonus money and go out and buy your company stock? If not, then you should sell your RSUs, because it’s the same situation either way.
In fact, the only reason you should hold the stock is if you want to make the bet that your company is going to do better than the overall market. People buy stocks all the time in hopes of outperforming the market even though the data shows they are more likely to underperform. But now you need to think about the risk of holding an individual stock compared to a diversified portfolio of investments. What is your total exposure to your employer’s stock and is it too much based on your retirement goals and risk profile? Not only that, your personal capital is tied directly to your employer. This means not only is your money invested in the company but your ability to earn an income is as well. If your employer is not doing well, your stock is likely underperforming and you could be at risk of reduced hours or being laid off.
Putting it all together
RSU’s are one of the more cut and dry forms of employee compensation. Due to the way they are taxed, it is usually recommended to sell the shares as soon as they are received. However, if you want to hold the shares just do so knowing how it plays into your overall financial plan. Consider your other forms of employee compensation (Employee Stock Purchase Program (ESPP), Non-Qualified Restricted stock units (RSUs) (NQSOs), Incentive Stock (ISOs) and the risk they carry as well. Consider how far away you are from retirement, and other goals such as college education or a second home.
Finally, in practice, I’ve seen many people use RSU’s and other forms of stock compensation as source of additional spending. They use the proceeds to take an extra family trip, remodel their house, or buy a new car. I would encourage you to see your RSUs and other employee compensation as an additional source of retirement savings. Doing so will not only strengthen your overall financial plan but will also help control spending. When you retire your RSU grants will no longer be around to subsidize your lifestyle spending which means you will either have to adjust your lifestyle or make sure your retirement portfolio is big enough to support your lifestyle without the additional income.
If you have questions about your Restricted Stock Units, other executive compensation, or how it relates to your overall financial plan schedule a phone call to discuss with a Phillip James advisor.
All the information contained herein is for illustrative purposes and should not be relied upon for tax, investment, or legal advice. You should consult with your fiduciary investment advisors to decide what is best for you based on your specific situation. It also helps if your advisor is also a tax preparer.