Restricted stock units (RSU) are a form of stock-based compensation used to reward employees. RSUs will vest at some point in the future and, unlike stock options, will have some value upon vesting unless the underlying company stock becomes worthless.

RSUs can be an important part of your client’s compensation package. As a financial advisor, your advice can assist a client in getting the most out of this portion of his/her compensation.

What to know about RSUs

An RSU is a grant whose worth is based on the value of the company’s stock. There is no value to the employee when issued. The RSUs will vest at some point in the future based on time passed or perhaps the achievement of a goal. They are then distributed as shares of stock but can be distributed as cash—although this is less common.

Until the RSUs vest, they are nothing more than an unfunded promise to issue shares of stock to the recipient at some point in the future. Holders have no voting rights nor do they receive any dividends paid while they hold the RSUs. Some companies will pay dividend equivalents on the RSUs. Companies can let dividends accrue and use these funds to cover some of the taxes due at vesting.

Once they vest and the shares are distributed, the recipient is taxed on the value of the shares at the time of vesting. They are subject to taxation at ordinary income rates plus the applicable state income tax rate.

There are four key points about RSUs that recipients should be clear on:

  • What causes the RSUs to become vested? A certain period of time or an employee's achievement of a goal or milestone.
  • What happens to the RSUs if specific events such as termination, retirement, or death of the employee occur?
  • What happens to the RSUs in the event of a change in control of the company?
  • How are taxes withheld when the RSUs vest?

What to Do With RSUs

Some companies may have made arrangements for employees to be able to receive a cashless distribution in which they will have enough shares withheld to pay the taxes due. There is no preferential capital gains tax treatment at vesting. With no opportunity for preferential capital gains tax treatment from holding the stock for a year, there is nothing to stop you from selling some or all of the shares if you so desire.

So should you retain the shares or sell some or all of them? Like most such questions, the answer will depend on each client’s unique situation.

Once vested, the RSUs are just like any other shares of company stock. The client should take into account all other shares of company stock held in taxable and retirement accounts. If the employer’s stock is a steady performer, the employee may be tempted to hold the stock—after all, there was no cost to obtain the shares.

Another way to look at this: A decision to hold the shares upon vesting is a decision to buy a company’s stock at the price on that day. If the shares have greatly appreciated, this is like buying at the top of the market and hoping that the shares continue to appreciate.

Remember that the RSUs are a part of compensation and should be treated as such. 

Trials of Diversifying

There are no hard and fast rules about allocation, but many financial advisors caution against holding more than 10% of your portfolio in company stock. Any concentrated stock holding is risky, but when it’s your own company’s stock, you run an elevated risk if the company falls on hard times.

If an employee loses their job with the company, it may be a result of the value of the stock from the RSUs and any other shares losing significant value. Combined, this could be a stiff financial hit.

Financial advisors working with clients who receive part of their compensation as RSUs should advise their clients regarding the best use of the stock. It is wise to think of the RSUs as a cash bonus; the decision is whether to “buy” company stock or invest it elsewhere to diversify.

Other Things to Consider

What happens if your client receives a job offer with a competitor before the vesting of some or all of his RSUs? You can help that client place a value on the RSUs which would be lost, and could then be used as part of the compensation negotiation between the client and potential employer. 

If there are significant unvested RSUs, it may also behoove your client to stay with his current employer until they're vested.

If your client’s employment with the company is terminated involuntarily, in all likelihood, any unvested RSUs will be forfeited. However, the firm may have an employment agreement or other arrangements that specify the treatment of RSUs. This is another key point that your client should have nailed down. 

At retirement, any vested RSUs are yours to do with as you wish. If you have unvested RSUs, it will depend on the plan and the company’s policies. If you stand to lose RSUs with significant value, it may pay for you to continue working until the RSUs vest.

Death or Disability

Most company plans will differ on what happens to RSUs in the case of death or disability. Don't just assume that the treatment of other benefits and compensation in the event of disability applies to RSUs and other stock-based compensation.

Planning Opportunities

RSUs and other stock-based compensation can be an addition to your client’s overall compensation package and can be a way for him or her to build significant wealth. 

If the client is poised to become vested in a significant amount of shares in a given year, the advisor can help him keep his other income as low as possible to minimize the tax impact. The advisor might also instruct him to lump any deductions from prior or future years into the year of vesting.

Moreover, the financial advisor should advise the client as to the best use of the shares of stock received. If the additional stock brings the percentage of company stock in one's portfolio to an excessive level, it would be logical to urge the client to sell shares and diversify his assets.

The Bottom Line

RSUs can be an important component of a client’s overall compensation package. A financial advisor can provide much-needed advice as to how to best handle what is essentially a bonus payment.