RSUs are one of the most common forms of equity compensation, yet so few people understand:
If you have RSUs, you need to read this:
RSUs are a type of compensation employers use as an incentive to keep employees there for longer. They do this by granting you shares of their stock over a certain time frame. Some are 2 years, some are 3, some are 4, etc.
Your employer will say we are going to give you 10,000 shares with a 1 year cliff and 4 year vesting schedule. This means the first 1/4 vest at 1 year = 2500.
Then they start vesting monthly after that = 208.3 a month. This continues on until you have them all or you leave. You are not able to sell any of the shares until they vest. Vesting simply means the date they truly become yours. If you were to leave the day before your 1 year anniversary, you wouldn't actually own any shares. This is how they are used to incentivize you to stay.
Let's go through an example to show you how this all works
Ex: you are an employee at Tesla and are awarded 10,000 RSU's on a 4 year vesting schedule. So 2500 shares vest in January. When January rolls around and those shares vest they become yours. And they are taxed as ordinary income on that date no matter what. It does not matter whether you sell them or keep them. This is a very important distinction. Think of it just like any other cash bonus.
So let me reiterate. The taxes are paid right when they vest and they typically sell a portion of your shares to cover those taxes (unless you choose against that). However, they do not know your exact tax liability. They typically withhold 22% if under $1mil and 37% if over $1mil. It is rarely the right amount.
With RSUs, tax planning is really important. You need to be doing tax projections to understand how much is under or over withheld so you can have the funds for tax time or to pay a quarterly tax.
Since the taxes are due the date they vest, you want to view this as a cash bonus.
Why?
Because if you sold that day you would not owe any more taxes. So you have the choice to liquidate and use elsewhere without any other tax consequences. Or you can continue to hold the stock. If you would rather put this money somewhere else, to a better investment, to pay off debt, etc. then it makes sense to sell the day they vest since the tax is already paid. If you think it's the best investment, then you leave it there.
But, understand that if you decide to hold onto the RSU's you are basically putting all your eggs in one basket and hoping this is the best investment for you. Holding 1 single investment brings risk as this could end up being a large part of your portfolio.
If you decide to hold on to the shares, then you will also get taxed again after the vesting date. If you sell within 1 year of the date your equity vested, then you will be taxed at short term capital gains rates which is taxed at your income rate. This can be anywhere from 10% - 37%. If you hold and don't sell till 1 year or longer, then you will be taxed at long term capital gains = 0%, 15%, or 20%. Long term capital gains rates are typically taxed more favorably, especially if you are a high income earner.
It is important for you to have a plan for your RSU's before they vest so you know if you will sell or hold on. It typically makes sense to either sell the day they vest, or hold past a year for favorable tax treatment. Again, you don't want to just hold because of tax treatment since with RSU's the taxes are due the date they vest. But if you like the stock, hold for awhile (past 1 year).
So as yours vest this year:
1. Plan ahead of time on the taxes and know what you will owe
2. Make a decision on if you are going to hold or sell
3. Know where those funds will go if you sell
4. Live your life
Thanks for reading! Hopefully this helped you better understand how to plan around your RSUs.
Financial Advisor