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Explaining Restricted Stock Units (RSU's) Thumbnail

Explaining Restricted Stock Units (RSU's)

Restricted Stock Units (RSU’s) have become a popular compensation tool for technology firms and a tremendous benefit for employees who receive them as part of their compensation package.  The purpose of this post is to explain RSU’s, how the work, what the tax implications are, and key considerations when deciding what to do with them.  

1.  What Are they?

Restricted Stock units are a grant of company shares (or the cash value of shares) that are awarded by companies to highly valued employees. They are typically attached to a vesting schedule that stretches over a few years, so they are a very effective retention tool.  They are similar to traditional stock options in several ways - the future benefit of the option is attached to the stock price and you must remain with the firm until they vest or lose them (in most cases).  They differ from traditional stock options in their tax treatment upon vesting among other things.  When compared to traditional stock options, RSU’s are pretty straightforward.

2.  How do they work?

An eligible employee will typically be given RSU grants at the time they sign an employment agreement.  The RSU agreement will outline a vesting schedule for the shares.  As those vesting “gates” are passed, the RSU’s are awarded to the employee.  

Example:

Jane recently joined XYZ, a publicly traded company,  as a sales representative.  As part of her compensation plan, Jane was offered an RSU grant of 10,000 shares.  At the time of signing, XYZ stock was trading at $10/share.  Her vesting schedule indicates she will vest 25% of her RSU’s after year one, and then the remaining 75% will vest quarterly for the following 3 years.  If she leaves XYZ company any time inside of that 4 year period, she forfeits any unvested RSU’s that are remaining.

3.  What are the tax implications?

Since there is no cost incurred by the employee to acquire them, the entire value of the RSU's is considered taxable income in the year that they vest.  At vesting time It is common for the employer to sell shares to cover withholding taxes, as well as deductions for EI and CPP before making shares (or cash) available to the employee.  The deductions by the employer are estimates, so employees need to be aware when they file their income taxes for the year that there may be a discrepancy between tax withheld by their employer for the vested RSU's and tax owing when taking into account all other sources of income.

Example cont'd:

After Jane’s first year, 25% of her RSU’s have vested (2500 shares).  The value of the shares has increased to $12.00/share.  Jane’s benefit is worth $30,000 CAD.  Her employer withholds income tax, CPP, and EI before making the shares available to Jane.  Jane is in the 46% tax bracket, so after withholding taxes she is left with 1350 shares worth $16,200 in her stock account.  Jane’s taxable income for this benefit is $30,000 this tax year.

4.  Key considerations

Once shares are vested and tax is withheld, employees can either cash in the shares or hold onto them in the hopes that they will continue to go up in value. 

If you are among the lucky group to have RSU’s you have some decisions to make with your RSU’s when they vest.  There are a few things to consider regarding your personal financial situation.  

Does the RSU award make up an important part of your personal financial plan?  

Would seeing a big loss in the value of the vested stock have a meaningful impact on your finances?  How about on your nerves and your mood? (this is not a joke, I know that watching the value of their company stock gives people a lot of nervousness)  

Do you have short term needs (ie. debt repayment, immediate capital needs like education for kids, purchase of a home)?  

If you answered yes to any of these questions it will be wise of you to sell the RSU proceeds at vesting, take the cash and take care to diversify out of your company stock.  In addition to the concentration risk of holding a big chunk of your invested net worth in a single company stock, if the stock struggles very badly it is possible that the company is struggling and that your employment may be at risk as well.   Yes, you may forfeit some upside - but the risks may be too much for you to bear.

Photo by Ishant Mishra on Unsplash

*Disclaimer - This blog is for informational purposes only.  If you have questions about your personal situation, please consult with your financial advisor*