RSUs, or Restricted Stock Units, are an increasingly popular way for companies, especially tech companies, to compensate their employees.
Simply put, an RSU is a grant given by an employer to an employee, promising to give them company shares at a future date, which is referred to as the vesting date. As RSUs vest, the full value of the vested shares is added to an employee's income and taxed accordingly. When the RSUs vest, the shares become available to the employee, and they can decide whether to sell or hold onto them.
Factors to consider in your decision include the company's stock price, potential future growth, and the employee's personal financial situation. It's ESSENTIAL to be aware of the tax implications of holding or selling RSUs. When the restricted stock units vest, they are taxed as ordinary income based on the fair market value of the shares at the time of vesting. Typically, a percentage of your shares can be sold at vesting to cover tax withholding, but often not quite enough for high earners. That’s another conversation for another day.
An additional wrinkle is if the employee decides to sell the shares after vesting: capital gains tax may apply if the eventual sale price is higher than the price when the shares vested.
There isn't a one-size-fits-all approach to handling RSUs, and the best strategy will depend on your financial goals and risk tolerance.
Factors to Consider
When deciding whether to sell your RSUs immediately or hold onto them, there are several factors to consider.
Evaluating the Stock
Take a moment to assess the underlying company's stock and its prospects for future growth. If you believe the stock price will continue to rise, holding onto your shares may be an ideal choice. Conversely, if you anticipate the stock prices to fall, selling your RSUs immediately could save you from potential losses.
Your Financial Goals
Consider your personal financial objectives and how selling or holding onto your RSUs aligns with these goals. Are you aiming for concentrated long-term capital appreciation in one company’s stock? Are you aiming for more diversified long term growth? Or do you need the cash from the sale of your shares for more immediate needs? Reflecting on your priorities will help you make a more educated decision.
Tax Implications
RSUs are typically taxed as ordinary income, which means that when your shares vest, the value of the stock at the time is considered part of your annual earnings. Consequently, you'll have to pay taxes based on your ordinary income tax rate. This tax event will happen REGARDLESS if you decide to sell your shares immediately. If you hold onto them after vesting, you may also need to pay capital gains tax on any additional gains above the market value of the shares at the time they vested if you sell them more than one year later. Any shorter, and the growth is still only short-term. If the shares fall in price after vesting, you still pay ordinary income tax on the price when they vested!
Timing of Selling RSUs
Selling RSUs immediately upon vesting is a common approach for many individuals. The reason behind this strategy is to avoid any potential decline in the company's stock value. By selling right away, you can lock in the value of your shares and mitigate potential risks tied to stock market fluctuations. You’re also locking in your tax burden on those shares.
If you believe in the company's growth prospects and future performance, holding onto your RSUs could result in a higher return on investment. However, this requires carefully weighing the risks against potential rewards and considering your overall financial goals and risk tolerance.
In addition, if your employer has recently gone public and the stock is subject to a lock-up period, you might not be able to sell your RSUs until the lock-up period expires.
During the lock-up period, insiders and employees are prohibited from selling shares to prevent market flooding and volatility. This is an important factor to keep in mind as selling cannot happen immediately as desired.
Ultimately, the decision to sell RSUs should be based on a thorough evaluation of your personal financial situation, goals, and the potential tax implications.
Alternative Strategies
Not all RSU situations are created equally! Here are some alternative strategies and scenarios that may apply.
Hold Your RSUs
One approach is to simply hold onto your RSUs and defer selling them. This could allow you to potentially benefit from future stock price appreciation. However, holding your RSUs also exposes you to the risk of stock price declines, and keeps you more heavily concentrated in your company’s stock.
Double-Trigger RSUs
With private company RSUs, we often see what are called double-trigger RSUs. These require two events to occur before they vest, such as both a time-based and performance-based condition. Often, the second requirement is a liquidity event, like an acquisition or an IPO. These RSUs aren’t actually a taxable event until both conditions are met, which presents another double edged sword: you don’t have to pay taxes on illiquid RSUs if they haven’t vested, but when they do, the timing can be hard to predict.
Sell RSUs Gradually
Another option is to sell your RSUs gradually over time, instead of selling them all at once. This approach can help spread the risk of potential market fluctuations and avoid turning all of your vested stock into cash at once.
Weighing the pros and cons of immediate selling is critical to optimizing our financial situation. On one hand, selling RSUs immediately allows us to diversify our investments, reduce risk associated with holding too much company stock, and make use of the proceeds for other essential purposes. On the other hand, holding onto RSUs allows potential capital appreciation if the company performs well in the long run.
Ultimately, the decision to sell or hold RSUs depends on our individual financial goals, risk tolerance, and the assessment of the company's future prospects. It's essential to consider tax implications, investment portfolio balance, and how quickly we can reinvest the assets into something more aligned with our financial objectives.
If you're still unsure about the best course of action for your RSUs, consider seeking the advice of a trusted financial advisor. Our team specializes in helping professionals navigate complex financial decisions, ensuring that you make the best choice for your future.
