Restricted stock units, or RSUs, are often used by companies as part of a compensation package for key employees. They are a form of deferred compensation often confused with stock options. Employers may offer restricted stock units in an effort to retain employees who have to may have to wait until a vesting period is up or risk forfeiting their stock.

Restricted stock units are a way an employer can grant company shares to employees. The grant is “restricted” because it is subject to a vesting schedule, which can be based on length of employment or on performance goals, and because it is governed by other limits on transfers or sales that your company can impose.

So technically, you don’t own any shares when you have restricted stock units — just the promise to have shares at some stated point in the future. Once you meet the stated conditions and your restricted stock units vest, then you can own the shares outright. Upon vesting, they are considered income, and a portion of the shares is withheld to pay income taxes.

A Look at Restricted Stock Units

Restricted stock units provide potential advantages to both the employer offering them and the employee who could receive them.

From the employer’s standpoint, restricted stock units may assist in retaining top talent. If the possibility of losing out on a potential large sum of money is there, an employee who was on the fence about staying or leaving might just stay to avoid losing out on the money. As they say in the behavioral finance world and the definition for loss aversion, the pain of loss outweighs the pleasure of gain.

From an employees standpoint, restricted stock can be considered a forced savings by some. Many companies issues restricted stock instead of giving cash bonuses. By placing the money in stock, there is the potential that over the course of the vesting schedule, the stock will rise. Let’s look at an example.

Say your employer gives you 1,000 restricted stock units of company stock worth $100 per share, with a 3-year vesting schedule.

Year 1 – 333 shares vest

Year 2 – 333 shares vest

Year 3 – 334 shares vest

To receive the benefit of owning all of those shares currently valued at $100,000, you have to continue to work with the company through the vesting schedule. Leave early, and whatever shares that have not vested are forfeited.

As mentioned above, one of the biggest benefits of Restricted Stock is when the price rises. Going back to the example above, if the company stock started at $100 per share, but increased at every vesting period, the total value of your RSUs could be much more than the initial grant as shown below.

Year 1 – 333 shares vest @ $110 per share – $36,630

Year 2 – 333 shares vest @ $130 per share – $43,290

Year 3 – 334 shares vest @ $150 per share – $50,100

This scenario would result in a total value of $130,020 as opposed to the $100,000 of the initial grant.

As with all stocks, there is no guarantee that the stock price will go up. If the price goes down, your RSUs drop in value. This aligns your goals with that of your employer. If the share price rises, you both benefit.

What Happens When RSUs Vest?

When an RSU turns into a share of company stock that you own, it is said to “vest.” So, the schedule on which the RSUs turns into stock for you is called the “vesting schedule.”

Upon vesting, you will often receive actual shares of stock that you own outright and can choose if you want to continue holding the shares or sell and concert to cash.

When your RSUs vest, you pay ordinary income tax on the entire market value of the shares you receive (that is, the price you’d have to pay to buy the stock “normally” on the stock market). The taxable value is calculated as:

Number of Restricted Stock Units x Share Price at Vesting = Taxable Income

Looking back on our example from above.

In Year 1, when 333 shares vested at $110 per share, that resulted in $36,630 of taxable income.

Determining the tax liability is based on your individual tax rate. If we assumed a 33% tax rate in our example the tax liability would be:

$36,630 x 33% Tax Rate = $12,087.9 taxes due

Most companies will handle the taxes on your behalf, by withholding taxes automatically. Again, typically they do this by simply selling some of the vested RSUs. Biggest thing to keep in mind is that they may not withhold enough taxes based on your individual tax rate and how you pay for any remaining tax liability is up to you.

You Own Company Stock… What happens Now?

You earned the grant, you waited, it vested, you paid the taxes and FINALLY, you own the company stock. Now that you have unrestricted shares of stock, it is up to you on what to do with them moving forward. We believe that it is important to consider how owning company stock fits into your overall financial plan and determining just how much company stock you should own.

Incorporating restricted stock into a financial plan and lifestyle budget can be complicated. This is where a financial advisor can help through comprehensive financial planning and determining the best liquidation strategy for you.