Running on autopilot can be dangerous. If a pilot’s course is off by 1 degree traveling from San Francisco to New York, they will end up 40 miles out in the Pacific Ocean. Likewise, if you don’t recalibrate your financial autopilot settings, you’ll miss your destination of financial security.
A particular setting that I find all my clients struggling with during their first review is management of their RSUs.
What is an RSU?
An RSU is a “restricted stock unit,” which is a fancy name for ownership in your employer’s company. Many tech and other industry employees receive RSUs as part of their regular compensation.
These shares are awarded at a regular time—typically around your review—but vest over 3-4 years. Vesting means you don’t really own all of the shares until that date is reached. For example, today’s awards that vest over four years will become yours in chunks of 25% each of the next four years. If you leave before the four years are up, you forfeit the remaining awards.
Think of RSUs as a delayed “bonus” payment. On the day they are awarded, you don’t know how much they will be worth because it depends on the stock price when they vest over the next several years.
When should I sell my RSUs?
Because this “bonus” payment comes in the form of stock, you have to decide when to sell the stock and receive the cash.
The first step is to determine how much of your assets are tied to the performance of your company. In other words, what percentage of your assets is in company stock? If it’s over 10%, you’re in the gambling zone. Your income already comes from your employer, and now a large chunk of what you own is tied to them as well. If you are okay gambling like this, so be it, but understand that it can quickly vaporize.
Even if your company investments are under 10%, I suggest creating a plan to sell all your vested shares to reduce your exposure. As mentioned, your income is tied to your company, and you likely have a significant portion of your wealth in unvested shares as well.
Remember, diversification is key to successful long-term investing!
What’s the plan for selling RSUs?
After you’ve decided to sell some or all your RSUs, you need a plan that accommodates the desire to reduce your company exposure and minimize the taxes you’ll pay. We’ll apply this to both the unvested shares and vested shares.
First, the shares that are currently vesting.
You are taxed on the full amount of RSUs on the day of vesting. That day’s market value of the shares goes straight to your W-2 (and usually shows up on your next paystub). It’s as if they gave you that amount in cash when, instead, they gave you stock.
Understanding this, if your company did give you cash instead of stock on the vesting day, would you immediately buy stock? I’m guessing no, but by holding onto those shares, your tax calculation is exactly as if you did! So, the best strategy is to immediately sell vesting shares.
Second, the shares that have already vested.
The situation is a bit more complicated for older holdings. It’s still true that the tax status began on the date of vesting, but now that you have a gain or loss, you have to consider whether it will be taxed as short- or long-term capital gains. This is determined by whether you’ve held the shares for at least a year after vesting.
By knowing the tax rates on individual vested amounts, you can calculate the “tax cost” of selling: the tax divided among the current amount of shares. Then, you can rank them from the lowest percentage tax cost to the highest.
Once you have the total tax cost, you can determine whether to take the “hit” today or over the next few years. If you take it over the next few years, you should begin by selling the shares with the lowest percentage tax cost. This allows you to sell the most value for the lowest tax cost.
What do I do with the cash?
RSU awards are no different than your salary. They are real compensation for your work, so why would you treat them any differently than your paycheck?
You can use your RSU awards to support your lifestyle (today and in the future), first by making sure your Savings Target is being met. Your Savings Target is a combination of your net cash needs over the next five years, and any additional Emergency Funds. Once your Savings Target is met, any remaining funds go into your long-term investment portfolio.
What gets in the way of selling my RSUs?
Two things get in the way of selling your RSUs: inertia and gambling (though people often don’t call it that).
The issue of inertia is simply that it takes effort to sell RSUs. You have to keep track of the vesting dates and log into a platform to sell them. Companies know that it’s difficult for people to be bothered with making an effort, which is why the compensation system is set this way. They’d rather you own the stock than cash them in!
The issue of gambling is that you’re attached to your company stock. You might believe it’s “too low” to sell right now, so you hold it when it goes down. Other times, you might think it will continue going up, so you hold when it goes up. If one of those cases is always true, when would you sell? You wouldn’t.
Is making an RSU plan that simple?
Yes! The toughest part is managing your emotional connection to the stock. Once you’re committed, all you need to do is sell your current RSUs as they vest, and your older RSUs according to the tax-wise method described above.
To learn more about RSU management and how to recalibrate your financial autopilot settings, click the button below to schedule your free consultation.