Big Picture, Financial Planning, Millennials

The Key Details Of RSU’s: Using Eli Lilly As An Example

Companies often look for opportunities to incentivize and pay their employees in other ways than just cash. Stock compensation is one of the most popular ways to do this. 

This past week, I was working on a plan for a client at Eli Lilly, and since so many people from Butler and Indianapolis work at Eli Lilly, I thought I would take a deep dive into how Lilly compensates employees outside of income and some things to consider. This can be applied to a lot of other companies who have similar incentives. Anyways, let’s get into it. 

Eli Lilly offers many of their employees restricted stock units (RSU’s). RSU’s are a form of stock-based compensation in which a company gradually transfers shares to an employee. With RSU’s, you are granted them and then at a certain point in the future they become vested. Vesting is basically when they become fully yours, but up until that date, they really have no significant value for you. 

At Eli Lilly, like many other companies, vesting occurs at multiple times meaning that some shares vest at 1 year, 2 years, 3 years, etc. with the goal of trying to incentivize you to stay longer since you don’t get those shares until that time period ends — but at the vesting date, that amount becomes fully yours and is considered income and taxed as such. This means that at your vesting date, you have already paid the full tax and now have to decide whether you should sell them right then or keep them for the future. I highly recommend working with an advisor and or CPA at this time to make sure proper planning around taxes and the options on the table are done (it is even better to work with them ahead of time to plan for it).

Note: You must acknowledge acceptance of your grant agreement(s) within the limited grant award acceptance period. For accounting and compliance reasons, you will forfeit your awards if you do not acknowledge acceptance online during this period (direct language from Eli Lilly’s handbook). 

When Do You Keep The Shares?

With RSU’s, you want to be mindful of whether you should keep or sell the shares after the vesting date. If you keep them, you need to be mindful of how concentrated you could be in one single company. Having such a large concentration in one company is risky no matter how much you believe in said company. Perfect examples of why are Enron and GE– companies people thought were unstoppable but ended up quite the opposite.

So, when can this risk be worthwhile? It’s hard to say because it’s hard to predict the future of companies. No one knows what is going to happen — but the best time to take this risk is if you really believe in the company and see a massive upside. A great example of this would be if you were at a company that could potentially IPO in the next few years.

Anyways, back to this specific client I am working on. At the vesting date, he/she will have over $30,000 in Lilly stock which will make up almost 30% of their investment portfolio. That is quite a bit. When does it make sense to keep those shares? Typically, it makes sense to keep the shares when you truly believe in the growth of the company and would be willing to put that amount of money into the company from your bank account. For this client, he/she would have to be willing to put $30,000 down for it to make sense to keep it all. If he/she wouldn’t do that because they think it would be better to have that $30,000 be put somewhere else, like a solid, low-cost, diversified portfolio, then it may make sense to sell the shares on the vesting date and reallocate the funds. However, if you really believe in the company and think it would be the best place for those $30,000, then you should keep the shares. Your individual beliefs in the company matter tremendously.

Why Does Selling On The Vesting Date Matter?

If you decide it makes sense to sell, it is best to sell on the vesting date because you have already paid the taxes at that point. If you choose to hold on and sell a month later, then you may have to incur short term capital gains taxes on whatever gains have occurred since the vesting date. Remember, short term capital gains are taxed as income at your ordinary income tax rate, which typically will be higher than your long term capital gains tax rate. So, if you don’t sell on the vesting date, anytime you sell between that day and 1 year, you will be taxed at short term capital gains rates (income tax rate). 

If you realize that the shares have vested and it hasn’t been a year, it may make sense to hold onto them for a year if you are at a high income tax rate or near moving up a tax rate. Consult your financial advisor and or tax advisor before making any decisions about this.

Key Takeaways

  • RSU’s are a form of compensation to employees to keep them at a company for longer
  • RSU’s have a vesting schedule, where on that date they completely become yours and are taxed as income. Many places have it staggered where a certain amount becomes vested each year.
  • If you truly believe in the company and think it would be a good investment (better than where you could reallocate the money to) then it makes sense to hold on
  • If you would rather reinvest those dollars in a different way, it may make sense to sell on the vesting date
  • If you do not sell on the vesting date, but do sell within the first year you will be taxed at your income rate on the gains
  • If you do not sell on the vesting date, but hold on for over a year then you are taxed at capital gains rate

This was meant to be high level and talk about the key points of RSU’s, if you would like to learn more about them here is a great resource to do so.

If you are looking for an advisor and want to learn about how this specifically matters to you and your plan, you can book a meeting with this link.

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