Planning for Restricted Stocks & RSUs

By Kelly Metzler, CFP®

Employee stock grants can be a valuable but complicated piece of the financial picture for executives. Restricted stock and restricted stock units (RSUs) have become an increasingly popular form of equity compensation over stock options. While they can be more straightforward than stock options in some aspects, restricted stock still requires careful comprehensive planning. From understanding vesting schedules and tax implications to making informed decisions about holding or selling your stock, crafting a well-thought-out strategy is essential.

Restricted Stock vs. RSUs: What’s the Difference?

Restricted stock and RSUs are both equity awards that grant you shares of company stock. They share many of the same issues, but there are a few key differences.

Restricted stock is a grant of company stock that becomes yours once certain vesting requirements have been satisfied. The stock is “restricted” because you can’t transfer or sell it until it vests.

With restricted stock units (RSUs), no shares are actually issued upon the RSU grant. Rather, RSUs are an unfunded promise to issue you a certain number of shares in the future once the vesting conditions have been met. RSUs don’t have voting rights and generally don’t have dividend rights like restricted stock does.  

Unlike stock options, there is no exercise for restricted stock and RSUs. Once they have vested, you have full ownership of the shares – you can hold or sell them just like any other stock that you own.

How Vesting Works

A vesting schedule for restricted stock outlines the timeline and/or conditions under which an employee gains ownership rights over the granted shares. In other words, it specifies when the employee's control over the restricted stock becomes "vested" or unrestricted.

Vesting schedules can either be time-based or performance-based. For time-based vesting, you must work at the company for a certain period before vesting occurs. A common schedule is over four years, with shares vesting incrementally – either monthly, quarterly, or annually – over that period. At the end of the four-year vesting period, you would have full ownership of all the shares from that specific grant.

Companies can also use performance-based vesting, where vesting is tied to achieving specific company goals or targets.  

How Restricted Stock & RSUs are Taxed

There is no tax implication for RSUs when they are granted. When the RSUs vest, you owe ordinary income tax based on the fair market value of the stock on the vesting date. You report this income regardless of whether you decide to hold or sell the shares.

Restricted stock is generally taxed upon vesting as well, when the restriction on the stock lapses. Taxable income is the fair market value of the shares at vesting. The exception to this tax treatment is if you decide to make a Section 83(b) election.

Section 83(b) Election for Restricted Stock

For restricted stock, employees have the option to make a Section 83(b) Election. With an 83(b) election, you are electing to be taxed on the value of the stock at the time of grant, rather than at vesting. If the stock price appreciates between the grant date and vesting date, you would have paid tax on the lower grant value. The election must be made and filed in writing with the IRS within 30 days of the grant. Section 83(b) cannot be made with RSUs.

This election isn’t without some tradeoffs to consider. If you make an 83(b) election you are reporting income and paying tax before the shares have vested. If the stock price goes down between the grant date and vesting date, you will end up paying more in taxes. Another consideration is the risk of forfeiture – if you leave the company before the stock vests, you will have paid tax on shares that you’ll never receive. There is no refund of that tax paid and no tax deduction for a forfeiture.

An 83(b) election isn't a one-size-fits-all decision; it depends on your financial situation, confidence in your company's growth and stock price, and your willingness to take on potential risks.  

Planning Considerations

It’s important for executives to understand how your equity awards fit in with the rest of your financial plan, especially if they make up a large part of your total compensation. As a financial advisor, this is a key part of the work I do with clients. Reviewing your grants and knowing how many shares you have vesting and when, is a good first step. Here are a few other things to consider:

Tax Withholding: Companies are required to withhold tax on compensation income to employees, which includes income from restricted stock and RSUs. However, the amount that your employer withholds may not be enough to cover the full amount of tax due on this income. For example, your company may only withhold based on a 22% federal tax rate. But if your true income tax bracket is higher than this, you’ll end up owing the rest of the tax liability come April 15th.

The Decision to Hold or Sell: Once your shares vest, you’ll have to make the decision to continue to hold the shares or sell them. It may seem like the path of least resistance to hold the shares, or you may be bullish on your company’s stock. However, you should evaluate your company stock ownership within the context of your total investment portfolio and level of risk. Equity compensation can often lead to single-stock risk – owning too much of any single stock increases the overall risk of your portfolio.

One way to reframe this investment decision is to think of restricted stock or RSUs like a cash bonus. If you were to receive a cash bonus of $25,000, what would you do with it – would you take the after-tax proceeds and go buy your company stock with it? That’s the equivalent of receiving $25,000 worth of RSUs and holding the shares.

Leaving Your Company: If you leave your company, you will forfeit any unvested shares. For this reason, equity awards are often used as a way for companies to retain employees. You should check your specific plan to see what happens to your shares in the event of retirement, death or disability, or if your company is acquired.

Conclusion

Stock grants can be a powerful way for executives to build wealth so that you can retire comfortably and maintain the lifestyle you’re used to in retirement. Having a plan that incorporates your restricted stock, RSUs, or other equity compensation will give you the confidence to know whether you’re on track for the retirement you want. If you’re ready to optimize your compensation and benefits, schedule a call.