Alright, we are back on the equity compensation train here. I know I have deviated a bit recently with other topics, however, I felt those were important enough to cover. Plus, it is important to mix things up every so often. But, again, we are back on track. The topic of this blog post is what the heck should you do with your RSUs once they vest? Sell? Hold? A bit of both? We’ll cover some items to consider.
As a reminder, RSU stands for Restricted Stock Unit. RSUs may be the simplest form of equity compensation, for a couple of reasons.
First, a Restricted Stock Unit is a right to receive stock after you have satisfied any conditions imposed by the company. The conditions can be as clear cut as working for the company for a certain amount of time or meeting a sales goal. If you meet the conditions then you get the shares. If not, well, then you don’t get them. I told you it was pretty simple.
Next, the taxation of RSUs is rather straightforward, however, there are two steps here. When RSUs vest (this means they are totally under your control and there is no more worry about losing them), you recognize the value of the RSUs as compensation income. This is simply the value at vesting minus anything you paid toward the Restricted Stock Units. Most often, employees do not pay anything toward RSUs, so the whole value at vesting is now taxable as though you earned that much. Many people consider this a “cash bonus,” which I get. So, if you have 100 shares of Restricted Stock Units that are worth $200 a share when they vest, you recognize income of $20,000. If by chance you had paid $50 toward each RSU, your taxable income would be $15,000, which is the difference between what you paid and its value at vesting.
The second part of taxation of RSUs has to do if you do not immediately sell your RSUs and hold onto them. Then you are dealing with capital gains taxes, which are often lower than ordinary income taxes. The example here is you hold onto your RSUs for another 5 years and they grow at a phenomenal rate from $200 at vesting to $500. You sell all 100 shares and the $30,000 gain is now taxed at long-term capital gains rates.
If you want more details on the basics of RSUs, you can go back and listen to an early episode I did. I believe it was number 18.
See, told you it was easy. Seriously, RSUs are simple in the sense they vest when they vest and there are no special tax treatments with them. However, they are much more complicated once you step back and look at the big picture.
Option One – Dump ‘Em
Your first option of what to do with RSUs is to dump them. Dump may be a harsh word, but an easy option to the question of what to do with your Restricted Stock Units is to sell them all as soon as they vest. I won’t call this the easiest, because most employers make you select if you wish to sell all your shares upon vesting. Most will just let you hold them, but maybe sell some automatically to cover taxes. However, any extra step makes it less simple. Even if that step is as simple as saying you want to liquidate them all upon vesting.
Now, there are advantages to selling all your RSUs. Some of these advantages will come into play if you continue to hold the shares too, so they are not benefits limited to selling.
First, you get the cash. As I mentioned before, many people consider RSUs a cash bonus. Maybe you have $20,000 of RSUs that will vest every year for the next decade, assuming you stay employed at your current firm. This means you have access to a nice annual bonus of potentially $20,000. Obviously, the value of the bonus fluctuates based on the actual share price, but I’m trying to keep things simple here. Regardless, having a nice bonus every year can be beneficial to put toward anything from college costs to annual vacations to anything in between. It is a nice, annual and one-time cash inflow.
Next, and this is a big one – you get to reduce any type of concentration risk issue you might have. You know – having too many eggs in one basket. Concentration risk is a huge issue I see frequently since I cater to people with equity compensation. It is like the frog in boiling water story as concentration risk slowly grows over time. All of a sudden you go from not having much of your investments in company stock to 30, 40, 50% or more. This happens via participating in things like Employee Stock Purchase Plans (ESPPs), getting RSUs, maybe Restricted Stock and even Non-Qualified Stock Options.
The big question you should ask yourself on a regular basis – if I was given $20,000 of cash this year (you know, the value of your RSUs this year), would I go out and buy $20,000 of my company’s stock? There is no right or wrong answer here, just one only you can answer.
Option Two – Hold ‘Em
Well, this next option is the complete opposite of selling everything as soon as it vests. Yep, it is holding onto the shares once in your control. There’s usually one of two reasons I see people go this route.
First, it is because the employee firmly believes in the long-term performance of their company stock. And I’m not talking about high level executives who are restricted in how much and when they call dispose of shares. I am referring to you are confident the shares now fully under your control will rise in value over the years. Basically, your answer to the question of whether you would buy this stock if you had the cash is yes, you definitely would.
The next, and more common reason I see people go the hold the shares route is due to sheer laziness. Well, maybe lazy is a strong word. However, it is because they just never elected to sell the shares once they were fully vested. I’m going to pick on a friend here. He doesn’t read my stuff so I have nothing to worry about. Not that he’s a scary guy or anything anyways. He is nearing retirement and has worked for the same publicly traded company for decades. He mentioned to me one day he was talking to one of the Fidelity advisors he has access to through a workplace benefit. The Fidelity employee was shocked at how much he had in stock. Well, the reason is because he never bothered to sell anything because he simply never got around to it. He never asked himself the question of whether he would buy the company stock on the outside. He simply let things ride. Fortunately for him, the company stock has done well and his inaction has helped him plan to retire earlier than he thought he would be able to.
One thing to mention with holding onto the shares, regardless of whether you are holding them on purpose or due to not taking any action to sell them. It may be in your best interest to go ahead and sell enough shares to at least pay the taxes due once they vest. Remember, they are reportable as compensation income so you will owe Uncle Sam. If your employer does not automatically sell enough to cover your tax bill, you may want to go ahead and sell. No reason to take a chance in selling down the road when the tax bill is actually due just in case the share values have dropped.
Final Option – Goldilocks Approach
I thought about calling this the King Solomon approach, but cutting a baby in half just feels so odd to use as an investment philosophy. Instead, I am going to refer to it as the Goldilocks Approach. This is basically figuring out the balance of the first two approaches. Selling some and holding the rest. Or, holding some and selling the rest, depending on your perspective.
Honestly, this is the approach I use with clients. The difference is there is no absolute decision saying you must sell this amount and hold this amount. No, it all depends on the individual situation. Factors to consider include things like how much you own in company stock overall, your risk tolerance level, the overall design of your investment portfolio, immediate cash needs, and most importantly, tax considerations. Now, there are other reasons, but these are some of the most common factors clients and I consider when deciding how much to hold and/or sell of Restricted Stock Units once they vest.
I am not going to dive into any examples for this approach as it is truly based on your individual situation. All I can say is make sure your CFP® is competent with the intricacies of equity compensation to create a personalized solution for you.
Alright, this seems like a good place to stop with this article. Hopefully it is helpful. As always, thanks for taking the time to read this. Please do not hesitate to reach out if I can be of help with your equity compensation-related questions. The easiest thing to do is to click the little green box that reads “Schedule a Meeting” that can be found at the bottom of every page on my website. Or, just click my Calendly link right here.
I’m Dan Johnson, CFP®, founder of Forward Thinking Wealth Management. I run a flat-fee financial planning and investment management firm located in beautiful Akron, OH. Although I am in Akron, OH, I work with clients regardless of location. I cater to owners of equity compensation positions who are looking to organize their financial lives, keep more of what they make, and do the things they want in retirement and even now.