Many employees in the Bay Area, especially in Silicon Valley, have restricted stock units (RSUs) that have been granted to them by their employer. These RSUs are one method that your company uses to retain talent. Back in the 1990s, many companies used stock options for this purpose, but these have largely been replaced by RSUs. Much of the confusion about how to treat vested RSUs dates back to the days of stock options. It is helpful to understand the differences.
Stock options are granted at a price that is determined when the grant is made to the employee. Typically, the options vest over a period of 4-10 years, with some percentage vesting each year. Once the options vest, the employee can exercise the shares at the grant price. Most of the time, employees will sell the shares immediately and take a cash distribution. The purchase price is the grant price and the sales price is the current market price. For example, if the options were granted at $10/share (let’s say 4 years ago) and the stock is now trading at $50, the employee buys the shares at $10, sells at $50, and realizes a $40/share profit. Taxes on this profit ($40/share in the example) are only due when shares are exercised (whether they are held or immediately sold). This is an advantage of options over RSUs, since you have control over when taxable gains are realized. On the other hand, if your company’s stock is below the grant price, the option has no value (it would cost you more to exercise than you would receive). Therefore, you would not exercise the option.
RSUs are quite different from stock options, although vesting schedules are similar. With RSUs, your company is effectively granting you company stock at a price that will be determined on the vesting date. When shares vest, you receive the vested shares at the market price on that date. The best way to think about this is that your company is giving you a cash bonus on the vesting date and you are using the entire bonus to purchase company stock. You owe taxes on the vested shares (ie., the cash bonus) on the date the shares vest. You have no control over the date of this tax liability. Companies need to withhold taxes on this bonus, so some of the vested shares are “sold” to cover your tax liability (although it may or may not cover the entire tax liability depending on your personal circumstances). Were you to sell the vested shares on the day of vesting, any capital gain or loss would only reflect the movement of the stock on that day. If you choose to hold the vested shares, then future capital gains or losses are determine based on the market price on the date of vesting.
When considering what to do with your vested RSU shares, you should consider whether given a cash bonus, you would go out and buy your company’s stock, or whether you would invest it in some other way. Factors to consider are:
- Do you believe your company’s stock will significantly outperform the market. Is it a good investment today.
- How much do you already have invested in your company’s stock (Vested RSUs, RSUs that vest in future, stock options, company stock in 401k, employee stock purchase plan) and is it prudent to add to this.
- Are you willing to accept the risk of non-diversification in your portfolio. Your company may seem stable and safe, but so did Enron at one point.
Many of us have a large percentage of our net worth tied up in our company, including salary, stock, unvested RSUs, options, and stock purchase plan, as well as other less tangible items like health insurance, life insurance, and disability insurance. In many of these cases, it might make sense to diversify your holdings to reduce the risk that is entailed in having such a concentrated investment position. Even if you believe that investing additional funds in your company’s stock is a good idea, it might make sense to sell a portion of the vested RSUs and invest the proceeds in a diversified portfolio.
