Experts at Glassdoor say that January is the most popular month for job changes, so if you’ve recently changed employers, you’ve got lots of company.  By now, you’re probably starting to get comfortable with your responsibilities, your coworkers and basic benefits like compensation, vacations and health care.

You also may have some new, more complex benefits to incorporate into your overall financial plan.  Over the next few weeks, I’ll be taking a closer look at equity compensation, that is, perks that encourage you to invest in the company you work for, over time giving you an ownership stake in your employer.

There are a number of ways companies can do this, including restricted stock units (RSUs), employee stock purchase plans (ESPP), incentive stock options (ISOs) and non-qualified stock options (NSOs).

If all of those acronyms immediately made your brain shut off, you’re not alone. I’ve run into many people who have had these kinds of benefits and have put off addressing them for years because of their complexity.

I’d like to break down these options and give you some tips on how to approach having them as a part of your compensation package. This week we tackle restricted stock units.

 

What are RSUs?

RSUs are the most common type of equity compensation that I run into.  Essentially, a company promises to give you company stock (or its cash equivalent) if you meet certain requirements (most often staying a certain period of time).  Both public and private companies offer this type of incentive. The promise sounds something like this:

XYZ Corp will grant you restricted stock units in the amount of 1,000 shares of company common stock. 1) One fourth (¼) of the RSUs will vest after a year of service. One fourth (¼) of the total grant will continue to vest each year thereafter.

Vest, in this case, is not a sleeveless garment.  It’s a technical term that refers to the moment the company fulfills its promise to you. In other words, it’s the point where your promise of stock or cash becomes actual stock or cash. The “vesting period” is the amount of time you have to wait in order for the promise to become reality. In this example, after one full year of service, you would get 250 shares. And at the end of each year after that you get another 250 shares.

Vesting periods can vary widely — some are annual, some quarterly, some monthly and others are a mix of those time frames. To find your particularly schedule, you’ll need to look at the “grant agreement” or “plan document.”

What if you leave your job too soon to meet the vesting requirements? Your units are typically given back to the company. Remember, though, you only have to give back the unvested units. So, in our example, if you quit after two years, you still get to keep the 500 shares of stock that have already vested.  You have to give back the 500 RSUs that haven’t.

The great thing about RSUs is that you don’t usually have to pay anything for them (which is one big difference between those and the other equity compensation approaches), but there are tax consequences when the units vest. I’ll get into more detail on that later.

If you work for a private company, you may notice an additional requirement of a “triggering” or “exit” event. That means you not only have to work at the place a certain period of time, you may have to wait until the company has an initial public offering (IPO) or is acquired by another company to get the actual value from them. This is referred to as a “double trigger.” Usually, if you leave the company after the time vest but before the second trigger, you still get to keep the amount of RSUs that have vested. RSUs in private companies get a little complicated, but I think Stock Option Counsel has some great info on these particular types of RSUs.

 

What are these worth to me?

After you meet your vesting requirements, the company distributes the shares or the cash equivalent of the number of shares used to value the unit. This is usually a 1-to-1 equivalent: you get 1 share of common stock for 1 RSU.

Your grant agreement will specify how to calculate the value of the stock.  The calculation may be based on prior business day’s close, average high and low for the day, real-time price or today’s close. For example, if your agreement specifies the prior day’s close and your vesting date is January 31st, you’ll have to look at the closing price on January 30th.

This number is important for a few reasons. First, it will let you know how much these units of stock are worth to you (money, money, money!). Second, the IRS makes you pay taxes on the fair market value of the stock once the units actually vest (barring any other restrictions).

So if you had 250 units and the stock was worth $50/share, you’ve just gotten a $12,500 bonus. The company usually withholds some of your vested shares in order to pay your tax liability.  They’ll refund you any amount that was over withheld. The remaining shares are yours to do what you’d like (subject to any blackout periods or trading windows which limit your ability to sell your stock).

 

What do I do with them now?

For simplicity sake let’s say that even after withholding, you have 200 units of your company stock worth $10,000.  What do you do with it? As you can imagine, that depends on your specific situation.

I like to start by asking the purpose of the money. Is there something that you were planning to do with this money? Or can this money help accelerate a pressing goal for you? Can this money help secure your financial foundation?

There’s always risk when you invest in the stock market. No one knows what will happen to the value of the stock. If your company is the next Google, you may find that your stock goes from $50/share to over a $1000/share at some point. That makes your 800 shares (in our example 1000 shares – 200 shares withheld for taxes) worth $800,000. But maybe your company is the next Pets.com. The company goes belly up, and your shares are worth nothing.

You can’t predict the future, so my approach is to only hold onto the shares that you can afford to lose.  In other words, this is play money that shouldn’t be counted on for retirement. That money should be diversified across many different companies, not just the one you work for, and other asset classes like bonds and cash. As a general guideline, your total investment portfolio shouldn’t contain more than 5-10% of your company’s stock.

My mantra is hope for the best and plan for the worst. We all have hopes of striking it rich some day, but sometimes the best-case scenario doesn’t come to fruition. If you need this money to do other things (pay off debt, buy a home or invest for retirement), it might be better to cash your shares out while you can and put that money to use.

Keep in mind there are different tax consequences for when you sell. Remember the day that your shares vest, they are considered income to you and you have to pay tax on their value. The value that you pay taxes on is known as your basis in the stock. If you end up selling the stock at an increased value say $60/share up from the $50/share, you have to pay additional tax on the $10/share in gain. If you’ve held the stock for a year or less, then you pay taxes at whatever your ordinary income tax rate is. However, if you hold the stock for more than a year that $10 is taxed at capital gains rates (currently 0%, 15% or 20%). So you could fall in the 35% ordinary income tax bracket and the15% capital gains bracket, which means you get to keep 20% more of your earnings if you hold the stock longer than a year.

You may also find yourself in a situation where you sell at a loss. If your basis was established at $50/share, and you end up selling it for $40/share, you end up with a $10/share loss ($8,000 in our example). You can offset that loss against other capital gains or against your ordinary income up to $3,000 per year and can carry forward any unused losses.

But again, if you need the money, I like the approach of selling RSUs (or at least some of them) to put to good use. If you sell immediately, there likely isn’t going to be that much change in the stock price, so you won’t owe much, if any, additional taxes.

 

Some final tips

I hope this explanation has clarified what you own, if you own RSUs, and how you can use them to reach your financial goals.  Here are a few last tips.

• Keep track of your grant agreement: There’s a lot of essential information in this document as it relates to your particular RSUs. So make sure to hold onto this for easy reference.
• Check for an FAQ sheet: In addition to your grant agreement, a lot of companies offer a FAQ sheet. This will also help answer common questions for your particular RSUs.
• Get help: What I’m providing today is just a general guide. Seek professional guidance from someone who can review your grant agreement and dig into the details of your specific grant, especially if you have RSUs in a private company. He or she can help you figure out how this assets fits into your overall financial life.

I would love to hear about your experience with RSUs. Contact me at the links below.