Last year you got a nice bonus in the form of Restricted Stock Units (RSUs). Now that a year has passed these RSUs are about to vest. What comes next? In this post, we will discuss tax implications and other important decisions you must make as your RSUs vest.
More money, more problems. In this case, your problem can become taxes if you are not aware of the tax rules surrounding your RSUs. When your RSUs vest, you have to claim income on the market value of the shares on the day that they vest. Typically, your employer will "withhold" some shares to cover mandatory tax withholdings. Much like your regular wages, federal, state, and payroll taxes are withheld at the time your shares vest. The fun begins when you want to sell your shares after vesting. Depending on how long you have held your shares, and the price you get when you sell the stock, it could make a big difference in the rate of taxes you pay. Effectively, the price of the stock on the day that your RSUs vest will become your cost basis in the newly acquired shares. Much like buying the stock on your own, if you hold the shares for more than 12 months, any gain on the shares will be taxed at favorable long-term capital gains rates. If, however, your shares are held less than 12 months after vesting, any gain on the shares will be taxed as if it were regular income. This could result in a 17-percentage point difference in tax rates for those in the highest income brackets!
As an example, let's say your 10,000 RSUs vested when the price of the stock is $10. This means that on your next W-2, you will show an extra $100,000 of income (10,000 vested RSUs at $10/share). At the time of vesting, your employer may withhold 30% for federal, state, and payroll taxes (to keep numbers simple). This means that they will "withhold" 3,000 shares, at $10 per share, for the tax withholding. Therefore, you are left with 7,000 shares that are currently worth $10/share. Let's also assume that you hold the shares until next year, at which point the stock has gone up to $15 per share. When you sell your shares, you will owe taxes on the gain ($5/share or $35,000). Assuming you are in the 15% long-term capital gains bracket, you would owe $5,250 in taxes ($5/share gain x 7,000 shares x 15%).
How much do you actually have invested in your company?
Even though taxes are important, you should not rely solely on tax implications when deciding whether to sell or hold your newly vested RSUs. One of the most important considerations is how much of your overall wealth is tied up in your company. To answer this, you need to look at your overall wealth, both today and what it is projected to be in the future.
If you are in a position where you are getting restricted stock as part of your compensation, it is also likely that you have other company benefits, some of which may be substantial. If you have a company pension, deferred compensation, stock options, or an employee stock purchase plan, you will likely have a substantial amount of your wealth already tied up in your company. Not only should you consider these benefits, but you should consider your future salary and bonuses. Adding all this up could mean you have significant exposure to your company. Continuing to hold onto your RSUs could mean that you are adding to your already substantial exposure to your company.
Further, what is your exit strategy? When do your stock options vest? When do they expire? When do you plan to take your deferred compensation or pension? Are you participating in your company's ESPP? How much of your 401(k) is in your company's stock? Are you getting RSUs in the future? If so, what is the vesting schedule? These are all questions that you should have some guidance on before pulling the trigger on selling (or holding) those RSUs. Coordinating all your various benefits can help you minimize the exposure to your company while maximizing how much you take home after taxes.
Keeping yourself in check
Let me guess, you think your company is undervalued and is going to double in the next 6 months? Quite honestly, I have rarely met anyone who has said they thought their company's stock was overvalued. The last, and most important, question you should ask yourself is, "Can I make an unbiased choice when it comes to selling or holding my company stock?"
The reality is, in most cases, the answer to this question is "no". Many people suffer from common biases that cause them to make suboptimal decisions when it comes to assets they own. For example, have you ever bought a stock that has subsequently gone down in value? Did you objectively reevaluate the investment and subsequently sell it? Or did you hang on thinking it would rebound only to have the stock decline further? Perhaps after holding, you said to yourself, "I'll just wait until it goes back to X price so I can break even." Seven years later, you are still holding on to that stock in hopes the company will be a turnaround. After all, you kept reading articles to confirm your original investment thesis.
There are over 7 billion people on this great planet we call Earth, and at one point in each of their lives, they will have gone through the mental gymnastics that I mentioned above. When it comes to any investment, this is the sort of game we play with ourselves and the reason it is sometimes so hard to part ways with those RSUs and other investments (even though it may be the best thing for you).
This is where having a neutral third party, such as us, can come in handy. We can help you objectively evaluate your options when it comes to your company benefits, such as RSUs, and help you make a decision that works best for you.
If you would like to download our FREE guide to help determine if you are exhibiting any of the above biases, and therefore would benefit from an advisor, please click here.