Restricted Stock Units (RSUs) versus Restricted Stock

One of the first questions we ask our tech professional clients (at WestStar we call them ‘Aviators’) is ‘what does your idea of a prosperous life look like?’ We often find the answer to this is why they reached out to us.

Maybe you want to get off the treadmill of tech by age 55, or maximize the opportunity of a future IPO to gain financial independence, or you have a growing family and are weighing up the trade-offs in giving them a great chance at life.

We always start with what you want out of life because the answer tells us what to pack into a financial plan that works as hard as you do to meet your goals.  Without clarity, it’s impossible to take focused action.

Tech professionals 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 Aviator clients are mainly in technology and aerospace. Many are software engineers who approach life as meticulously as they write their code. They’re concerned with doing all they can to protect and provide for their families. Most are worried about taxes eating away at their portfolio, and are looking to learn more about optimizing their finances, and ensuring they‘re doing everything possible to maximize their compensation benefits, lower their taxes, and grow their wealth.’

Spencer Hill, MBA, Financial Consultant

Restricted stock and RSUs offer significant rewards to those who manage them astutely, but these rewards may become missed opportunities that can be costly. The trick is to know the rules and restrictions, and exactly how your restricted stock options can benefit you.

Restricted Stock Units (RSUs) Versus Restricted Stock – What are the Differences?

Today, companies use restricted stock and Restricted Stock Units (RSUs) for broad-based grants, often in combination with stock options. Let’s unpack the differences between restricted stock and RSU’s and what these 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 regulations 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 called 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 well 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.

Check out our Financial Flightpath Blog on Understanding Restricted Stock Unit Taxes.

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 six key features worth paying attention to are:

• Vesting triggers. Understand what factors trigger vesting – whether it’s 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.
• Management of concentrated stock risk.

For many years we’ve spent a good amount of time explaining to our Aviator clients how you should start thinking about your vested RSU’s as part of a 360˚ financial plan. We most often look to diversify their additional income between savings, investments, and retirement accounts and to save that money into a more diversified portfolio of equity investments, instead of staking their future on the fortunes of one company.

To read up on how to Incorporate RSUs into your investment strategy and avoid concentrated stock risk, Click here.

Click here to learn more about how to optimize your RSU position with WestStar’s Aviator NavAid.

WestStar Prosperity Partners’ Advisor Team guides and mentors many highflyers. Our ‘advice in plain English’ approach brings confidence and clarity to managing your compensation programs, and we help you make and implement decisions with a long-term financial plan in mind.

“Along with our Aviator clients’ financial success comes a great burden and a real challenge to being happy, and balancing their life’s priorities.  We help them attain true freedom, independence, confidence and joyful living.”

Sam Gullette CFP®, CLU®, Certified Financial Planner ™

If you have questions about your specific circumstances, or want to make sure you’re equipped with the guidance and advice to pursue your future with real confidence and clarity, please get in touch. We welcome the opportunity to chat with you.

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We wish you every success in the future and hope to hear from you soon.

Sam Gullette & Erik Alexander

Disclosures: “A diversified portfolio does not assure a profit or protect against loss in a declining market.”.

“Asset allocation, which is driven by complex mathematical models, cannot eliminate the risk of fluctuating prices and uncertain returns.”