Maximizing Wealth with Restricted Stock Units (RSUs): A Guide for High-Income Earners
For high-income earners, especially those working for publicly traded companies, equity compensation in the form of Restricted Stock Units (RSUs) is a powerful wealth-building tool. RSUs provide an opportunity to benefit from your company’s growth, but they also come with complex tax implications that require careful planning.
In this article, we’ll cover the essentials of how RSUs work, common vesting schedules, detailed tax strategies, and why working with a financial advisor is crucial to making the most of your RSUs.
What are RSUs?
Restricted Stock Units (RSUs) are a form of equity compensation granted by employers. Unlike stock options, RSUs don’t have an exercise price—once they vest, they automatically convert into shares of the company’s stock. However, the real complexity comes with the vesting and tax treatment of RSUs.
How Do RSUs Work?
1. Grant Date
At the grant date, your employer informs you of the number of RSUs you will receive, but you don’t yet own the shares. No taxes are owed at this stage since the shares haven’t vested.
2. Vesting Schedule
RSUs are subject to a vesting schedule, meaning you only own the shares after meeting certain time or performance conditions. Vesting schedules typically fall into one of these common patterns:
● Time-based vesting: For example, you might vest 25% of your RSUs each year over four years. After the first year, 25% of your shares vest, and so on until you're fully vested after four years.
Example: If you’re granted 1,000 RSUs with a four-year vesting schedule at 25% per year, you would receive 250 shares each year until fully vested.
● Cliff vesting: In this case, all of your shares vest at once after a certain period of time (e.g., 100% vesting after three years).
● Performance-based vesting: The vesting may depend on achieving certain company goals, such as reaching a revenue milestone or stock price target.
3. Tax Implications at Vesting
When RSUs vest, the market value of the shares is considered taxable income to you at ordinary income rates. This amount is reported on your W-2 form, and your employer may withhold some taxes, but typically not enough to cover the full tax burden for high-income earners.
Navigating Taxes with RSUs
One of the trickiest aspects of RSUs is the tax treatment at vesting and when you sell your shares. Here’s a detailed breakdown:
Tax at Vesting
At the moment your RSUs vest, the market value of the shares is included in your taxable income. This income is subject to:
● Federal income tax
● State and local taxes (if applicable)
● FICA taxes (Social Security and Medicare)
Withholding Warning: While employers typically withhold taxes at a flat rate (often 22%), this may not be enough for high-income earners. If your effective tax rate is higher (which is common for those in higher tax brackets), you could be left with a significant tax bill when you file your return.
Strategy: Sell-to-Cover
A common strategy to cover the tax burden at vesting is the sell-to-cover approach. In this scenario, your employer sells a portion of the vested shares to cover the estimated taxes, and you keep the remaining shares. This helps manage cash flow but reduces your overall ownership in company stock.
Example: Let’s say 1,000 shares vest, and the market value is $50 per share, meaning your taxable income is $50,000. If your employer withholds 22%, they would sell approximately 220 shares to cover $11,000 of taxes, leaving you with 780 shares.
While this helps cover immediate taxes, it's crucial to remember that the 22% withholding may still be insufficient if you're in a higher tax bracket. You may need to adjust your withholdings or make estimated tax payments to avoid penalties.
Taxes When You Sell Your Shares
Once your RSUs vest, the shares are yours to sell whenever you choose. Any gain (or loss) after vesting is subject to capital gains tax:
● Short-term capital gains: If you sell your shares within one year of vesting, any gain is taxed at your ordinary income tax rate.
● Long-term capital gains: If you hold the shares for more than one year after vesting, any gain is taxed at the more favorable long-term capital gains rates (15-20% for most high-income earners).
Common Pitfalls and Tax Planning Tips for RSUs
1. Plan for Adequate Withholding
High-income earners often find that the default tax withholding on RSUs is too low. Without proper planning, you could face a large tax bill when you file your return. Here are some steps to mitigate this risk:
● Increase your withholding: You can ask your employer to withhold more taxes from your regular paycheck to compensate for the RSU income.
● Make estimated tax payments: If you know your RSUs will push you into a higher tax bracket, consider making quarterly estimated tax payments to cover the shortfall and avoid penalties.
2. Manage Concentration Risk
It’s easy to become over-invested in your employer’s stock, especially when you receive a significant portion of your compensation through RSUs. This can expose you to concentration risk if your company’s stock price drops.
Action Step: Diversify your holdings by selling some of your vested shares and reallocating the proceeds to other investments. This can help protect your portfolio from downturns in your company’s stock.
3. Understand Blackout Periods
Many companies have blackout periods during which you are restricted from trading company stock. These periods often coincide with earnings announcements or other significant company events. Be aware of these restrictions so you can plan your sales accordingly.
RSUs and Long-Term Financial Planning
RSUs can play a pivotal role in working towards achieving your long-term financial goals, but it’s essential to incorporate them into your overall financial strategy. Here’s where your financial advisor can help:
● Tax-efficient selling strategies: Your advisor can help you determine the best time to sell your shares to minimize taxes, whether that means selling immediately to cover taxes or holding for long-term gains.
● Portfolio diversification: By selling some of your shares, you can reduce concentration risk and diversify into other asset classes to ensure a more balanced portfolio.
● Cash flow management: RSUs can significantly impact your cash flow when they vest. Your advisor can help you plan for large tax payments and reinvestment opportunities to maximize your wealth.
Why You Should Work with a Financial Advisor
The decisions you make about your RSUs today can have a long-term impact on your financial future. Managing the tax implications, planning for adequate withholding, and avoiding concentration risk require a well-rounded approach that integrates your RSUs into your broader financial plan.
At LA Wealth Management, we specialize in working with high-income earners like you to develop strategies that help maximize the value of equity compensation. We can help you:
● Manage the tax implications of vesting and selling your RSUs.
● Plan for sufficient tax withholding to avoid surprises.
● Create a personalized strategy for selling shares to meet your financial goals.
Final Thoughts
Restricted Stock Units are a valuable tool for building wealth, but they come with complex tax and financial planning considerations. By working closely with your financial advisor and tax preparer, you can potentially make the most of your RSUs while minimizing the risks and tax burdens.
If you’re navigating RSUs and want to help ensure you’re making the most of this opportunity, contact us at LA Wealth Management. We’ll help you develop a personalized strategy to integrate your RSUs into your broader financial plan and help maximize your wealth.
Sources
● “Guidance on the Application of Section 83(i)” https://www.irs.gov/pub/irs-drop/n-18-97.pdf
● “How Restricted Stock and Restricted Stock Units (RSUs) Are Taxed” https://www.investopedia.com/articles/tax/09/restricted-stock-tax.asp
Securities and Advisory services offered through GWN Securities, Inc., Member FINRA/SIPC, a Registered Investment Advisor. 11440 N. Jog Road, Palm Beach Gardens, FL 33418. (561) 472-2700. L.A. Wealth Management and GWN Securities, Inc. are separate companies.
Asset allocation and diversification do not guarantee a profit or protect against a loss in a declining market.
The examples in this article are hypothetical and for illustrative purposes only.
Information provided should not be considered as tax advice from GWN Securities, Inc. or it's representatives. Please consult with your tax