What are Restricted Stock Units: How to Avoid a Huge Tax Bill

Restricted Stock Units are a great way to build wealth, but they come with tax rules you have to know. In this video, we break down exactly what Restricted Stock Units are and how they are different from stock options.

Resources:

- Alliance of Comprehensive Planners: https://www.acplanners.org

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TRANSCRIPT:

John: Hey, Bridget. I was talking to a friend of mine the other day, and he said that his company gave him some restricted stock units. And he asked, “What things do I need to know and how do I think about these?” And I thought that would be a really great question to dig into. Of course, you deal with that with clients too. When a client says, “Hey, I got new RSUs, what do I do with these things?” what do you tell them? What are the pros? What are the cons? How do you talk about it with clients?

Bridget: First, I say, congratulations! It's an awesome question to have. RSUs are sweet. So let's talk about them. They're generally part of someone's compensation plan. And they grant them in year one. And then typically the vesting starts the next year and then goes over a series of years. And often it's three years. And sometimes it's every month.

So sometimes it's like you're getting these all the time, but it depends on the company. And so, when they vest, then you get the shares and the price of the shares minus some tax is included in your compensation. So that'll be on your W2 when you get these shares. So that's the first thing to understand. Anything to add to the basics?

John: No, I think that's a great explanation. And I think it's like getting a bonus. Say you have 75 shares of stock, and you get 25 each year that vest, that become yours. And it's just like getting a check or cash, except it's in stock. So there're some other opportunities that come with it, and it kind of ties the person to the company in some fashion. Hey, I want the company to do well, so my shares go up in value. I don't think I've got anything else to add other than it's like getting a bonus but in stock.

Bridget: Absolutely. So then the shares either go up or down. And if you hold on to them for a year, then any gains are capital gains, so they're taxed at a lower rate. So I think that's what the companies have in mind when they include them as part of your compensation. They want you to hang on to them and you'll care more about this company than you ever did before because your future is tied to this company.

John: Let's walk through that if you could. I love this. Let's say I'm your client, and I come to you right now. I got 75 shares. I get 25 that vest each year. So next December, I'm going to get 25 shares at vest. The company stock is, let's say, $100 a share. It goes through the year. Today I know what it could be worth, but I won't know what my 25 shares are actually worth till a year from now. So next December, we sit down, and now the company's gone up. It's $110 a share or whatever it is. I still get those 25 shares times the per the share price. That's my bonus for the year. Now next December, I own 25 shares of XYZ Company. So I own 25 shares of that. That value shows up in my W2.

Bridget: Right.

John: I don't have any money yet. I have a stock. That's one of the things that’s important to be aware of. Hey, I gotta pay tax on that, but I don't have any cash yet. And then now that I own this stock a year from now, that's the point where I can say, listen, now I can do whatever I want to with those 25 shares. I could sell them right away. I could hold them for a year like you said, and then I pay capital gains basically in two years down the road. It's sort of like two separate decisions. One, I get this bonus, and it's in stock, and I'm going to pay taxes on that. Well, what do I want to do with it?

And one of the things we talk about with folks is at that spot, a year from now, I've paid taxes on those 25 shares. If I wanted to sell them right away, I could sell them and there'd be maybe no gain at all. I could sell them and just turn them into cash if I wanted to. Sometimes I can't do that, but most of the time you can, in my experience. At first, nothing happens, but in a year from now, I'm going to have that tax bill attached to the stock, and then I've got some decisions to make. It's not just, “Well, I'm done now.” Now I got to think about, “Hey, I own this stock.”

Bridget: Absolutely. So I would talk about when you can't sell, and that is if you're an insider. If you’re an insider, you should know it. But if you suspect that maybe you are and you're not quite sure, it's important to know the status. And so, if you're an insider, then you're subject to certain trading windows. And this is because you presumably have inside information that might move the market if you told somebody else. And you have to be confidential about all the information that you share.

So you can't just go selling stock whatever you feel like it. Okay, so it’s slightly different for insiders than it is for the rest of the people. The other thing I see that happens is often people start a company, then they get some shares, they never sell them, and what everybody's hoping for is the shares will go up. I'm sure there's know plenty of listeners that are in some of these companies from which they got restricted stock units, they didn't sell them, then they go way up.

John: Yeah.

Bridget: And so, then you have a lot of capital gains baked into those shares, but then they're worth a lot and that can be a big part of your net worth.

John: Good problem to have, right?

Bridget: Yeah. But that's when we start saying, “Sell these right away.” So then on the new shares we'll tell them to sell them right away because you don't need all your eggs in that company basket. Sure, it's okay to have some shares in the company you work for, but once it gets to be a lot, what if they lay you off? That's going to mean the stock price is probably going down and you're losing your job at the same time. So you're putting a lot of risk on one thing by owning a ton of shares.

And then the other thing is that if you move up the ladder at the company, you might not even be able to avoid having a lot of shares. So they might be compensating a lot with RSUs and other stock options, etc. That's a thing to be mindful of. Owning a lot of it sounds good, but then it really increases the risk, because if that stock plummets, you lose a bunch of money. And most of the people at this point have seen enough stock market ups and downs that they get what I'm talking about. Sometimes people with new companies don't quite believe me.

John: I love that. I’m just gonna pull on a couple of those threads there. One of the things that we talk about is risk and concentration. If I have a lot of stock, it's one thing. But where's your livelihood? My buddy is pretty well compensated. He's a tech wonk. He's not doing the finances. He's not at a super high level. He's got this bonus coming. If things go south with the company, the economy, whatever it is, his wages are subject to the company doing well, and I think too much of his net worth is subject to the company doing well.

Of course, when it goes up, it all looks awesome, but when it goes the other direction, why take that risk? That's one of the things that we talk about. And I think the mistake that I see people make with RSU is not paying attention to concentration. If you sort of ignore it, it just shows up. Oh, look, my paycheck was higher and I got more withholdings. And you don't pay attention to it. And then two or three or five years down, suddenly you go, “Oh, half my net worth is in my company stock.” It sounds crazy, but it can be easy to forget that because you didn’t write a check for that stock. It's just different.

And so, paying attention to it is really critical, and what I'll tell people, Bridget, is rather than thinking about it like stock, when those RSUs vest (so a year from now when I've got those 25 shares times whatever the price is) if I got that bonus in cash, would I buy that number of shares of my company stock today because that's effectively what you're doing. I could turn it into cash tomorrow. A year from now, Bridget, would you buy $25,000 worth of your company stock? And if the answer is, “Yeah, I'd love to!” Great, then keep it.

If the answer is no, if I got a $25,000 bonus check, I wouldn't buy more stock with it. Then why keep it just because it came to you in the form of stock? And that's one of the reasons companies do it. They want people to kind of get attached to the stock. But just think about it. If I had this in cash, because I could turn it into cash tomorrow, would I make this purchase? And that, I think, is a really helpful way to separate some of the emotions from the facts and to be able to make a good decision about whatever's right for your situation.

Bridget: Absolutely. And I’m now christening that strategy ‘the closet rule,’ because that's how one of my friends cleans out her closets. She thinks, “Would I buy this particular item today?” No. Okay, I'm getting rid of it.

John: I was just thinking about that, because we're doing some of that this time of the year at our house. Oh, I really like this shirt. I haven't worn it all year, but I really like it. But if I wouldn't buy it today, why would I keep it? It’s the exact same thing. I love that.

Bridget: Yeah. So anyway, it's a good way to lighten things up. Another little mini rant from Bridget here is that I think some of the forgetting about it is by design. I think that the companies all have to have a separate RSU custodian, a holder. And the websites are horrible—all of them. So even our highly paid executives are asking us for help to fricking make these trades and get a statement. And God forbid the company pays dividends, because then they should report that on their 1040.

And so, then they need that 1099, and they can't find that. And the other thing is that you'd think that it would get better, but no, here's how they're designed. You log in and they seem to say, “You have tons of money if you just stay with this company.” That's kind of what the message is. But some of these might not vest for like 10 years. A lot of them are three years but some aren’t. Anyway, the message is don't leave the company. And I would say they make it hard to actually execute transactions. That's my two cents.

John: Yeah, I’m laughing. Oh yeah, getting those tax forms. In some cases, there’s no login for it, so you’ve got to call. It's a mess. So hey, I think that's a great place to wrap things up. And I'm going to remember the closet rule when I talk to clients about RSUs.

Bridget: Help people with their stocks and help people clean their closets.

John: There you go. That's awesome. Hey again, I'm John Scherer, and I run a fee-only financial planning practice in Middleton, Wisconsin.

Bridget: I'm Bridget Sullivan Mermel. I've got a fee-only financial planning practice in Chicago, Illinois. John and I are both taking clients, but we also belong to an organization called the Alliance of Comprehensive Planners. And so, if you want to meet in person with planners in your area, you can check acplanners.org.

John: And don't forget to hit that subscribe button.

At Sullivan Mermel, Inc., we are fee-only financial planners located in Chicago, Illinois serving clients in Chicago and throughout the nation.  We meet both in-person in our Chicago office and virtually through video conferencing and secure file transfer.