Compensation for the work you perform isn't only about dollars and cents; sometimes you'll be presented with stock options as part of your compensation
Salary plus vacation plus insurance plus stock options and restricted stock units (RSUs) equals compensation. When you start talking about how much a position pays, it's important to keep everything in mind, because the benefits and RSUs may make up for any shortfall in salary.
So, what do you need to know about stock options and RSUs? The knowledge you glean from this article will give you some ammunition when it is time to negotiate job terms. We'll start with a cheat sheet of terms and definitions.
Your cheat sheet - aka definitions
What are RSUs? They are Restricted Stock Units, which can be offered as a part of the compensation plan offered by an employer
Why do companies prefer RSUs? Since an RSU gives employees an interest in how well the company does, employers feel that they increase productivity
What is the difference between RSU and stock options? As an employee, you can buy stock options at a specified price; they are vested on a set schedule. RSUs are considered “restricted,” allowing employers to give them to top talent based on a set vesting schedule or when an agreed achievement has been accomplished.
What does vested mean? The stock doesn't belong to the employee until it is vested. The stock can't be sold until it is vested. Once it's vested, it's assigned fair market value and is considered taxable income. At that point, it can be sold.
RSUs vs stock options. RSUs are considered to be better, because they can be converted to stock. Options can only be purchased at market price. The RSU you receive today costs you nothing and will likely be worth more than today's stock prices when it finally vests.
Now that the general knowledge portion of the program is done, let's dive into the meat and potatoes of why RSUs and stock options are so important as a part of a compensation package.
What are Restricted Stock Units?
Basically speaking, it's a promise from employer to employee. The company is confident that the abilities of its current team, plus the value you offer, will result in growth. What you have to realize is that this promise of future growth isn't guaranteed. If you elect to accept the RSU option, you have to wait. Once the RSU is vested, it will convert to stock.
RSUs are great for ensuring employee retention, because if you leave before the RSU vests, you lose it. If you stay through whatever vesting schedule the company creates, then you can cash in on the promise… literally.
Vesting schedules can vary depending on what the company elects to offer. Some companies align vesting with goals or career progression or, for others, the vesting schedule may be timed. The timed ones are usually based on years.
For example, if there's a big project in the pipeline, the company may set goals for each part of that project. Once a goal is achieved, a number of RSUs will vest. Each successfully attained goal will equal another amount of vested RSUs. Once the project is finalized, all promised RSUs will have vested, and the employees now have stock options.
How are Restricted Stock Units taxed?
This is where RSUs and stock options vary greatly. If your company grants stock options, you don't have to pay taxes on them until you sell the stock, usually as capital gains. On the other hand, RSUs have slightly different tax implications.
RSUs are taxed when they become vested as ordinary income. Depending on your employer, you can have a certain number of RSUs withheld to cover the taxes, or you can choose to pay the taxes yourself. Since they are taxed as ordinary income, the percentage will correspond to whatever tax bracket you're in based on your annual income. Many people ask, “Do RSUs get taxed twice?” Well, it can appear that way if you live in a state with a state income tax. You'll have to pay both federal and state taxes.
If the company you're interviewing with brings up RSUs as an incentive, or part of their compensation, you should be aware of your current tax bracket to understand whether the amount offered versus the amount you'll pay in taxes makes the benefit worth it.
According to the IRS, the tax brackets are:
35% for incomes over $231,250 ($462,500 for married couples filing jointly);
32% for incomes over $182,100 ($364,200 for married couples filing jointly);
24% for incomes over $95,375 ($190,750 for married couples filing jointly);
22% for incomes over $44,725 ($89,450 for married couples filing jointly);
12% for incomes over $11,000 ($22,000 for married couples filing jointly).
Of course, since RSUs and other stock options are only available when you have a job at a publicly traded company, you're probably in a tax bracket that's higher than 22%.
Should I sell my Restricted Stock Units immediately?
The short answer is, “Yes!” Since RSUs are taxed when they vest, it's best to take advantage of their value. While you can hold them, there's no value because the performance of a single stock isn't going to make that big of a difference to your investment portfolio. Generally speaking, investments should be diversified, meaning spread out across stocks and bonds, for you to realize any advantage in investing.
If you do decide to hold them, it should only be done as part of a strategy and if you think the company's value will significantly increase over time. Also, if you've started investing but don't have the diversity in your portfolio you'd like, then your RSUs could help in that arena. Not placing your RSUs into a diversified portfolio can be equated to gambling - the risk is probably not worth it.
Do you pay tax when you sell a Restricted Stock Unit?
It depends. If you sell the RSUs immediately, you won't be taxed on the money you receive because you already paid income tax on them. However, if you hold them and their value changes, you'll be taxed for any capital gains.
An example of how Restricted Stock Units work
Now that you know the basics – RSU meaning, RSU vs. stock options, RSU vesting, and stock options as compensation – let's look at a scenario to see how they work.
Sam is interviewing for ACME Rockets. The hiring manager offers Sam 2,000 RSUs to complement the salary package of the job. The company's vesting schedule says that the RSUs will vest at a rate of 400 RSUs each year starting on his first anniversary.
After five years, Sam will become fully vested. He will pay taxes on them at 24%, based on his income bracket, and he'll have 2,000 shares of stock with the company. Sam decided that, when he reaches that point, he'll sell them immediately. That turns his RSUs into what amounts to a cash bonus.
Always remember that you're in control of your finances. If you're interviewing for a company that offers stock options or restricted stock units as a part of your compensation package, feel free to negotiate the amount. If you can't get them to budge on the RSUs they offer, you can negotiate the wage they pay. Compensation is rarely set in stone on the job offer. It can, and should, be negotiated.