RSU Vesting: A Guide to Understanding Restricted Stock Units

By Katherine K. Burgess, CFP® | Mar 06, 2024 |

Restricted stock units (RSUs) have emerged as a popular form of employee compensation incentive, especially in the tech industry. RSU vesting represents a promise of future equity in a company, typically granted to employees as part of their overall compensation package.  

However, the process of RSU vesting, wherein these units become wholly owned by the employee, can often be complex and confusing.  

Here’s what you need to know to make the most of RSUs. 

Understanding RSUs vesting

RSUs are a form of equity compensation in which employees receive units or shares of company stock as part of their remuneration. Unlike traditional stock options, RSUs do not require employees to purchase the shares outright. Instead, they are granted RSUs with a vesting schedule attached.  

Vesting refers to the process by which employees earn the right to the RSUs granted to them over a predetermined period, often contingent upon certain conditions such as tenure or performance milestones. Until the RSUs vest, employees do not have full ownership or rights to the underlying stock. 

RSU vesting schedule

RSU vesting typically follows a company-set schedule. This schedule outlines when and how RSUs will become fully vested and available for employees to exercise or sell. The most common vesting schedules are time-based and cliff-based. 

In time-based vesting, a certain percentage of RSUs become vested at regular intervals over a specified period. For example, an RSU grant might vest 25% each year over four years, with the first portion vesting after the first year and subsequent portions vesting quarterly or annually after that. 

In cliff-based vesting, there is a waiting period, typically one year, before any RSUs begin to vest. Once the cliff period expires, a significant portion of RSUs vests simultaneously. After the cliff, the remaining RSUs may vest according to a time-based schedule. 

Factors influencing RSU vesting

Several factors can influence the vesting of RSUs beyond time or cliff-based schedules: 

Performance conditions

Some RSU grants may be subject to performance conditions, such as achieving specific financial targets or milestones. If you don’t meet performance reqs, you may not get your RSU grants.  

Employment termination

The terms of RSU agreements often stipulate what happens to unvested RSUs in the event of employment termination, whether voluntary or involuntary. Depending on company policy, unvested RSUs may be forfeited or continue vesting for a specified period post-termination. 

Mergers and acquisitions

The treatment of RSUs in mergers or acquisitions can vary. Some agreements may accelerate vesting upon a change in control, ensuring that employees receive the full value of their RSUs before or immediately after the transaction.  

Tax implications of RSU vesting

RSU vesting triggers tax implications for employees, even though they haven’t yet sold the underlying shares. When RSUs vest, the market value of the vested shares is treated as ordinary income, subject to withholding tax. The employee’s W-2 form captures the income for the year in which the RSUs vest. 

If employees choose to hold onto the vested shares, any future gains or losses upon selling the shares will be subject to capital gains tax treatment. The tax consequences of RSU vesting can vary based on individual circumstances and tax laws. Consider a tax professional for guidance. 

RSU vests, like bonuses, are often subject to a 22% statutory withholding instead of the employee’s marginal tax rate. Thus, many employees with a large portion of their compensation tied to equity vests will experience high tax bills in April and are often subject to under-withholding penalties. Work with a CPA or tax advisor to determine whether increasing withholding or making quarterly payments makes sense to avoid penalties.   

Let’s use an example. Sarah works at Amazon with a base salary of $200k and annual RSU vesting amounts of an additional $150k/year. Upon each vest, shares are withheld to cover the 22% statutory withholding, and Sarah only sells shares when she needs larger chunks of cash for vacations and home projects. She often has a large tax bill and is looking for help to reduce her tax burden yearly because she has to cover the tax bill from her emergency savings account in April. In Sarah’s case, her advisor recommends selling a portion or all of her shares at the time of vest to diversify her portfolio and set aside cash for her upcoming expenses. This allows her to avoid incurring additional capital gains and plan for her taxes. She also works with her CPA to make estimated tax payments throughout the year so there are no surprises at tax time.  

Maximizing the benefits of RSU vesting

To make the most of RSU vesting, employees can consider the following strategies: 

  • Diversification: Employees may sell some of their vested RSUs to diversify their investment portfolio and mitigate concentration risk upon vesting. 
  • Tax Planning: Understanding the tax implications of RSU vesting can help employees minimize their tax burden. Strategies such as tax-loss harvesting or timing the sale of vested shares can optimize tax efficiency. 
  • Financial Planning: Incorporating RSU vesting into long-term financial planning can help employees achieve their financial goals, whether saving for retirement, funding education, or achieving other milestones. 
  • How we think about RSU vesting: Think of an RSU vesting event as a cash bonus that you receive on a scheduled basis. The question we will ask at each vest is, “Would I buy shares of XYZ company with these bonus dollars I just received?” If you have other uses for that cash or would like to purchase other investments with those dollars, we would consider selling the vested shares right away to avoid any additional tax implications or price movement.  

RSU vesting is a significant component of employee compensation, offering the potential for substantial rewards based on company performance and individual contributions. By understanding how RSU vesting works, employees can navigate this aspect of their compensation package more effectively, making informed decisions to maximize the value of their RSUs while managing associated risks and tax implications.  

As with any financial matter, seeking guidance from financial advisors or tax professionals can provide valuable insights tailored to individual circumstances, ensuring that employees maximize this valuable benefit. 

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