Restricted Stock Units (RSUs) versus Restricted Stock –what are the differences?
Because employees and executives make a big impact on any company’s success, companies strive to align the interests of their high-flying personnel with those of their shareholders. They do so by using company stock to incentivize their best and brightest. By issuing or selling company stock to key employees, companies get them thinking and working like owners.
Today, companies use restricted stock and Restricted Stock Units (RSUs) for broad-based grants, often in combination with stock options. What then is the difference between restricted stock and RSU’s and what does it mean to you as the stockholder?
What is Restricted Stock?
Restricted stock is a grant of non-transferable company stock made directly to you, and may be subject to certain vesting conditions, such as continued employment. As the holder, you have legal title to the stock which the company may repurchase if vesting conditions are not met.
Your restricted stock generally becomes available to you under a graded vesting schedule that can span several years. As long as you continue working at your company, you will not forfeit your grant, and it won’t expire.
The key traits of restricted stock include:
- Restrictions on sale and risk of forfeiture exist at grant, until you meet vesting conditions that may include employment duration or performance targets.
- Vesting may accelerate due to a life event such as disability or death, or a corporate event – like an acquisition or merger.
- Dividends are paid during the vesting period, and grant-holders have the same voting rights as shareholders.
- Because most restricted stock is granted to those considered to have insider knowledge of the company, restricted stock is often subject to insider trading under SEC Rule 144. Failing to adhere to these regulations can result in forfeiture.
What are Restricted Stock Units (RSUs)?
Unlike restricted stock, RSUs are not an actual transfer of stock on the grant date, but rather a pledge by your employer to transfer stock or cash equivalent, once vesting conditions have been met.
RSUs are issued in the form of units and not stock, and entitle holders to a specific number of shares in employer stock at future dates and subject to a vesting schedule. Often, the measurement is 1:1, meaning that each unit is exchanged for one share of stock upon settlement.
Vesting can happen incrementally over the vesting period (graded vesting), or a large percentage of the shares can be delivered at once on a single vesting date (cliff vesting). Employees are contractually entitled to exchange the units for stock or cash or some combination of the two, depending upon the terms of the agreement.
Typically, your restricted stock units are converted to shares over time, or as company goals are met. Once your RSUs convert to shares, you own the shares and can sell or transfer them. When the vesting occurs in any blackout period, employees may not sell the stock, and the Administrator retains the right to defer the delivery of the Stock until the blackout period ends. Blackout periods are generally two weeks to a month in duration and coincide with the release of earnings at the end of fiscal quarters.
An RSU is a full value stock grant because the grant is worth the full value of the shares at the time of vesting. Ordinary stock options are only valuable if the market value of the stock is higher than the grant price at some point in the vesting period: RSUs, however, will always result in income to you (unless the stock price drops to $0%), since you don’t have to pay for them.
How do you choose whether to hold or sell your company stock?
With most restricted stock units, the delivery of shares occurs at vesting. Your choice to hold the shares or sell them is an investment decision and will depend on the company and its growth prospects
In some cases, it may be best to sell your shares when you receive them, and add the proceeds to a well-diversified investment portfolio. In others – particularly in high-growth sectors – where your company is performing and looks to have a bright future, it may be best to hold them.
Unlike holders of restricted stock, holders of RSUs have no shareholder voting rights and do not receive any dividends that the company pays to its shareholders. However, a company may choose to pay dividend equivalents on RSUs.
Companies and employees often prefer RSUs to restricted stock for several reasons
As no shares need to be issued upfront with RSUs, they are easier to use when vesting is performance-based, since they can be easily canceled if performance conditions are not met.
As a full value stock grant, no shares are issued until the time for delivery, and this eliminates a large portion of administrative costs and hassles. Automatic share withholding for the taxes at vesting can be easier because no shares were issued.
For more on Understanding Restricted Stock Unit Taxes click here.
Your RSUs are taxed as ordinary income when they vest and convert to shares, not when you receive them. Your taxable income is equal to the fair market value of the shares transferred to you. For tax purposes, the entire value of vested RSUs must be included as ordinary income in the year of vesting. In other words, your vested RSUs are seen as supplementary income by the IRS and will appear with your compensation income in your W2.
If the shares are sold immediately, there is no capital gain, the only tax due is on the income. However, if the shares are held beyond the vesting date, you’ll also pay a capital gain (or loss) tax when you sell them.
As to managing your RSU grants, the 5 key features worth paying attention to are:
- Vesting triggers. Understand what are the factors triggering vesting – whether the length of your future employment, or the meeting of your (or your company’s) performance goals, and the terms and conditions of the vesting schedule.
- Specific events. Understand what happens upon events such as the loss of your job, your retirement, disability, or death.
- Corporate events. Understand what happens in any merger or acquisition.
- Withholding tax. Understand how tax withholding is handled.
- Management of blackout periods. Understand the blackout periods and their impact on the delivery of shares at vesting
Restricted stock and RSUs present a noteworthy complexity and offer significant rewards to those who manage them astutely. Conversely, these rewards become missed opportunities that can be costly. The trick then is to know the rules and restrictions, and precisely how your restricted stock options can benefit you.
For more on How to Incorporate RSUs Into Your Investment Strategy & Avoid Concentrated Stock Risk, read our article here.
Highflyers are busy people doing high-demand jobs, and many find managing what they’re earning difficult and frustrating. They fear making poor decisions, and not making the most of what they’re offered. What’s to be done about it?
“My clients come to me needing advice and direction on what to do to ensure a successful future during and after their careers. Most are young professionals who are entangled with their work lives and want me to help them take advantage of everything available to them. This can consist of many things, such as stock options, investment allocation, investment taxes and so forth.” – Aaron McDermott, Financial Consultant
Click here to learn more about how to optimize your RSU position with WestStar’s Aviator NavAid.
WestStar Prosperity Partners’ Consulting Team guides and mentors many highflyers. We understand just how valuable restricted stock and RSU employee compensation plans are. To make sure you’re equipped with the knowledge and advice to pursue your future with confidence and clarity, don’t hesitate to get in touch.
Disclaimer
The return and principal value of stocks fluctuate with changes in market conditions. Shares when sold may be worth more or less than their original cost. A diversified portfolio does not assure a profit or protect against loss in a declining market.