The first question that many of my clients who work in tech ask me is: When should I sell my Restricted Stock Units (RSUs)?
Typically, the answer is that they should sell as soon as they vest, and this article will help you understand why I recommend that.
Restricted Stock Units or RSUs are the most common type of employee equity my Silicon Valley tech professional clients own. RSUs are employee equity in the form of company stock which you vest over time. After you vest, you own the stock and can keep it or sell it. If you leave your company, you still own the stock.
Tax Treatment for RSUs
It’s critical to understand the tax treatment for RSUs. When you vest your RSUs, you are immediately taxed on their value which is treated for tax purposes as ordinary income. That means that your RSUs are taxed at the same rate as your salary. This is different from other types of employee equity such as Incentive Stock Options (ISOs) which are not taxed immediately when you vest them. My clients often think RSUs are treated the same as other employee equity such as ISOs which confuses them.
One way that is helpful to think about RSUs is to view them as a cash bonus in the form of company stock. Imagine you get a cash bonus. That bonus would get taxed immediately as ordinary income and you would be left with the remaining cash. If you took that cash and you bought your company stock in the stock market, you would own your company stock in the amount of your cash bonus. Said differently, you would be in the exact same place as you are when you vest your RSUs.
Let’s look at an RSU example
If you vest $100,000 of RSUs, your company will typically sell $30,000 of RSUs to cover taxes and put $70,000 of RSUs in your employee stock account. If instead, you got a $100,000 cash bonus, your company would typically withhold $30,000 to cover taxes and pay you $70,000. If you then took the $70,000 and bought your company stock in the stock market, you would own $70,000 of your company stock. In both cases, you end up with $70,000 of your company stock.
Now that you understand that you should view your RSUs as a cash bonus, the question I ask my clients is: If your company gave you a cash bonus today, would the first thing you choose to do with the money be to buy company stock?
When asked this question, most clients say that buying company stock would not be the first way they would use a cash bonus. If that’s the case, you should not hold on to your RSUs. If you do keep your RSUs, you’re saying that buying company stock would be the first way you would use a cash bonus.
Using RSUs to fund other goals
This is typically why I recommend my clients sell their RSUs as soon as they vest and use the proceeds to fund other financial goals including near term goals such as funding an emergency fund or down payment or long term goals such as investing for retirement in a broadly diversified, globally allocated portfolio.
When I recommend this, clients often have reasons they want to hold on to their RSUs; the most common is that they want to keep a stake in their company. I remind them that they are already invested in their company in the form of their salary, benefits, and future equity. If they still want to keep a stake, then we limit the stake in their company stock to ~10-20 percent of their investable assets so that they’re not taking on too much risk by holding too much of a single company stock.
RSUs do not carry a tax benefit
Because RSUs are taxed as ordinary income, there is no tax benefit in holding RSUs. Some clients will argue that if they hold RSUs for more than a year, the RSUs will qualify for the lower long-term capital gains rate. However, the long-term capital gains rate only applies to the gain from the stock price on the vesting date. If you bought stock on your vesting date and held it for more than one year, that stock would also qualify for the long-term capital gains rate. You get the exact same tax treatment if you hold your RSUs or buy the stock so there is no tax benefit in holding RSUs.
Let’s revisit that RSU example
If you held your $70,000 of RSUs for more than a year and you sold them for $80,000, your $10,000 gain would qualify for long-term capital gains treatment. Alternatively, imagine you took your after-tax cash bonus of $70,000 and bought $70,000 of company stock, held it more than one year, and sold it for $80,000. Your $10,000 gain would also qualify for long-term capital gains treatment. Again, there is no tax benefit for holding RSUs.
Given that RSUs are taxed as ordinary income and there is no tax benefit for holding them, I recommend you sell as soon as you vest and use the proceeds to fund your other financial goals.
Another way to figure when to sell your RSUs is to ask yourself: If I got my company gave me a cash bonus today, would I use it to buy company stock? If you wouldn’t use your bonus to buy company stock, you should sell your RSUs.
Deciding when to sell your RSUs can be hard to figure out. When you make that decision using the framework I’ve outlined in this article, you will be able to make the most of your hard-earned RSUs.
If you would like help developing your RSUs selling action plan schedule a free call with me to talk through your individual situation.