Understanding Restricted Stock Units #195

Restricted Stock Units (RSUs) are a popular form of equity compensation that companies use to reward employees. Instead of getting cash or the option to buy stock, you are promised a specific number of shares of company stock, provided you meet certain conditions.

In this episode Josh Nelson and Jeremy Bush give a breakdown of how they work, the timeline, and the inevitable "tax man" visit.

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Podcast Editor: Tim Leaman/info.primegen@gmail.com

Transcript

Wiser Financial Advisor – Understanding Restricted Stock Units 

Hi Everyone, and welcome to the Wiser Financial Advisor podcast, where we get real, we get honest, and we get clear about the financial world and your money. This is Josh Nelson, a Certified Financial Planner, founder and CEO of Keystone Financial Services. Let the financial fun begin!

Josh: I have a guest today. Actually, I wouldn't even call him a guest, right? He's part of our team, Jeremy Bush. We are two of four financial planners here at Keystone Financial Services. Jeremy and I are both Certified Financial Planners (CFPs), which is the gold standard when it comes to the financial planning industry. Today we're going to talk about Restricted Stock Units. Welcome, Jeremy.

Jeremy: Thanks for having me. Hot topic for our clients.

Josh: Yeah, and I think a lot of our clients know that we have kind of a niche in the corporate world in general, in that we work with a lot of people who work for a big tech company. Some work in another sector, but something a lot of them have in common is that they're sometimes highly compensated, not just with their salary, but they also receive equity awards, Restricted Stock Units, or maybe other types of rewards. 

Restricted Stock Units (RSUs) are the most common way we see that companies reward their employees by providing ownership in that company. We talk to clients about RSUs every day and how to manage those. It's a big deal whether the company's stock goes up or down, a really big deal as far as people's outcomes.

Jeremy: We've seen in our clientele what a huge boon it can be to their financial situation, if the company does well. But there are some pitfalls they can fall into with that, and there’s much to unpack.

Josh: That’s why today we'll be talking about what RSUs are, and then unpacking not only the implications and how they work, but also from a strategy standpoint, how do you manage those over time and how do you integrate them into your financial plan. Before we get started, of course, we need to let you know that this is just our opinions. Jeremy and I will always have an opinion if you ask us. We also have some expertise in the financial planning area. Tax is a huge part of the Certified Financial Planner curriculum. We are not tax advisors, just to be clear, so any tax advice should be from your CPA or tax advisor. But we are going to have a great general discussion, on how this stuff works and from a practical standpoint, what we're seeing with clients. So, to get started, Jeremy, what are Restricted Stock Units?

Jeremy: A Restricted Stock Unit is a form of equity award. It's a form of part-ownership in the company. We refer to these as golden handcuffs a lot of the time, right? Because the company will pay somebody a salary to work there, but then if they want top talent to stay around, they'll give Restricted Stock Units (RSUs). 

Let’s say they give you a grant of 1000 shares. Depending on the vesting time frame, some companies do an annual vest, so all 1000 shares come due and they're yours a year from when you get them. Most of them that we see are quarterly vesting, so they'll give you a grant and then every quarter, one fourth of those will vest or however they break it up. Basically, you have ownership in the company as you continue to work there.

Josh: And every company works differently, so how their vesting works is specific to their plan. It's important to understand that schedule. Understand how your company works, and also know that each grant of shares may have a different vesting schedule. It depends on your position in the company. It could be that they have a special award for everybody, one that comes out all at once, or it could be that everybody has RSUs that are vested over four or five years even. And back to the golden handcuffs, that's a reason why companies like these, right? Because if the stock's done well, it makes it financially painful for somebody to jump across the street, say, to another tech company.

Jeremy: It really does, because when you have these vesting shares, if you leave before they vest, you lose them. They just go away. So, it's really easy, especially for someone getting close to retirement, to say, “Well, I really want to retire, but if I work just one more quarter, I get X amount of dollars.” We've seen that one more quarter become one more year and then when the year is up, another 6 months because they can get those shares vested.

Josh: It can be significant, too. We can be talking about tens of thousands of dollars, hundreds of thousands of dollars, millions of dollars in some circumstances. That's why they're called golden handcuffs because it makes it pretty hard to turn down those RSUs. We have a lot of clients on the quarter-by-quarter plan who say, “I'm going to go one more quarter.” And obviously, people can't work forever. You have to recognize that you may be leaving that money on the table. Some companies offer a benefit where if you're retirement-eligible, there are factors that kick in if you've reached a certain age or number of years of service. Then you may get to keep your shares or have them vest out even after you've retired. More often than not, though, we see companies that don't do that. It’s designed to keep their top talent around.

Jeremy: And it's also important to distinguish between RSUs and your regular stock options, right? A stock option is something that is granted and then when it comes due, you have the right to the option to buy if you want. But say your grant is at $10 and the stock price is at $5, then it doesn't make sense to exercise that option. Whereas an RSU is literally just, “This is the price of our stock today, and this is what you get.”

Josh: Stock options can be far riskier. We saw this happen in the early 2000s for employees of Hewlett-Packard (HP). That company was a big presence in Northern Colorado at that time. They did a spin-off of Agilent Technologies. And everybody who had HP stock at the time or worked for the company received what was called a founder grant of stock options. They were priced really high in 2000 before the tech wreck. Then things plummeted, and I'm pretty sure that when those expired, they ended up being worth nothing. So RSUs are probably a safer deal for employees simply because it's a more certain thing. Unless your stock goes to zero, you're going to be receiving  a certain amount of value. We don't often see stock options anymore. Sometimes, once in a while, but most companies are using RSUs these days.

Jeremy: Yeah, it's definitely the more popular option.

Josh: Let's talk about taxes. That's a big deal, because if you're receiving RSUs, they’re part of your compensation. How does that work? Say I get 1000 shares of a company's stock as an employee of that company. Say I have to wait a year until they start vesting. They're restricted stock units. So as those become UNrestricted, how does that work for taxes?

Jeremy: When they vest, it gets reported as ordinary income to the IRS. So, if you're getting RSUs and they come due, you look at your pay stub, right? There's a separate line item under ordinary income that says RSUs. Every company does it a little differently, but most have a set percentage that they will send to the IRS. What we usually see is somewhere around the 22% range. So, if you have 1000 shares, they'll calculate 22% of the value of that and withhold those shares to be sent directly to the IRS. However, the employee could be in the 35, 37% tax bracket, but the company is only withholding 22%. Right off the bat, that creates a potential tax situation for a lot of people.

Josh: So, going back to the tax advisor thing, you need to make sure you're planning it out and not just assuming that your company is withholding enough taxes. We've seen some unpleasant surprises at tax time. People have said, “Wow, I had to write this huge check. I thought it was already taken care of.” It could very well be that it's just not enough withholding and so you're having to make extra payments. We've got a number of clients that need to make quarterly estimated payments on top of that withholding, especially in companies where their stock price haa done well. It's a significant amount of compensation that people end up getting. It's not really a choice because those are vesting each quarter, whether you want them to or not. You're not having to think about it a whole lot, but you are being taxed on it for whatever the value is on the day that it vests.

Jeremy: It’s important to work with either a financial planner, tax planner, or a combination of both. Those are the people who can dive into the numbers and project out and say, “This is what's being withheld right now, and this is what it looks like you're going to have to pay at tax time.” Nobody likes a tax surprise when they file. Somehow, it's a lot easier to swallow when you can see it coming. Just for peace of mind, it's definitely a good idea to talk to those professionals if you don't already have them.

Josh: Sure is. And we do a lot of tax planning with clients. We don't file your taxes. We're not tax advisors. You should still have a tax advisor. But we do have software with some pretty good optics, right? If we have all the information, we can help you see what could be coming. 

The other thing to think about is state taxes, because this is ordinary income. This is not just your withholding for federal. Some states don't have a state income tax, which is great for you, but others have a very high state income tax, which could be significant as well. 

Concentration risk is another one that comes up a lot, especially if the company's stock price has done very well. We often see that you could end up with too much in one holding. Using my early career example of Hewlett Packard, a lot of people had a plan to accumulate stock, either because they had stock options or a stock purchase plan. And the company stock had done well, I mean, it was a great company for decades, right? The stock price was pretty consistent, so people just left it there. They would never sell unless they needed it to pay for their kids' college or something like that. Many people just didn't sell. Then leading up into the late 90s and early 2000, we saw the tech bubble burst. All of a sudden, many of these tech companies went to zero if they were dot-coms or something like that. Even big, stable names like HP or Cisco or Oracle, these big tech companies’ stock prices went down 70, 80% or more. Many of them came back. It's not like they didn't come back eventually, but when you're looking at a 70, 80% loss, that's going to take a while. If your student loan bill is due soon, that's not going to be good in situations like that.

Jeremy: Yeah, there is a definite risk of getting too concentrated into one stock, right? The general principle is that you don't ever want more than 10% of your portfolio in any one company, and even that's pretty risky. We tend to say 5 is probably a safer bet, but you get into a number of biases when this comes up. You have recency bias, confirmation bias, which means you look at the past time frame. If it's a year, two years, five years, and your company's been doing great, you tend to lend more of your bias to, “Why in the world would I sell all this stuff? It’s been doing great for a long time, so why would it go down?”

We can give you numerous times throughout history, numerous companies, where that's exactly what happened. That’s why we always preach diversification. And RSUs can be a blessing and a curse, right? You can get a really big influx of money. Then if you lean on those biases too heavily, that concentration risk goes from 5% to 20, 30, 40%. We've seen up to 80 or 90% concentration risk for some people over time. And the longer you hang on to it, the bigger your tax situation becomes, and the more painful it is to unwind it when you do. So, there are a lot of factors to consider.

Josh: It's just a lot of risk. Our grandmothers or grandfathers, parents or advisors always told us, “Don't put all your eggs in one basket.” But there’s a normal human reaction to whatever's happening right now. We say, “Well, that trend is going to continue,” whether it’s up or down. Sometimes in really bad markets or bad situations for certain companies, maybe the stock is tanking. It's easy to think it's going to keep going down all the way to zero. Maybe that won’t happen. But it's important to recognize that money is an emotional topic. As much as we might think it's just dollars and cents, it's easy to get emotionally sucked into deciding to do something, or in the case of RSUs, maybe not decide to do something. 

In a number of cases, we’ve seen people accumulate more and more shares, which works great when the company is doing well, but then the environment changes. It may not even be something specific to the company that changes. It could be that other companies have gotten more competitive, right? It could be the overall market or economic environment. It could be things totally out of the blue, like the pandemic or 9/11, situations like that. How could you predict those? In situations like that or during the financial crisis where the market was down over 50% from top to bottom, you could have owned stock in the best companies in the world, and they still went down a lot. There was no place to hide in a market like that. So, each individual has to look at their own risk tolerance and ask, “How much concentration do I really want in this one thing.?” It's important to be thoughtful about it and have a plan. It's a mistake, I think, to just unconsciously let things go without a plan for how you're going to manage it.

Jeremy: We see that a lot too, right? We've had numerous people come to us who weren't clients but eventually became clients, and they didn't know enough about RSUs or how they worked. For a number of years they thought they would just let them build, let them do their thing. Then they come to a financial planner and say, “I have all this money, 60% in one company, and I've had it for years and it's done really well. What do I do with this?” That becomes a different kind of conversation then.

Josh: Yeah, sure does. We've seen it happen even in inheritance situations where somebody worked for a company for decades.  People had a substantial amount of their net worth or maybe almost all of it in companies like GE or General Motors. Then the kids inherited the funds and they thought Mom and Dad had a bunch of money. Well, they used to have a bunch of money, right? But then all of a sudden, those stocks tanked. This is not to pick on any individual companies. It's just to illustrate the principle of, “Don't put all your eggs in one basket.”

It's a risk tolerance thing. There's never been a bear market that wasn't followed by a bull market eventually, not that we can guarantee that. But with individual companies, we can point to quite a few. For example, Blockbuster Video. Great company, best company in that space for a long time. Then they didn't adapt fast enough. I think they actually had the opportunity to buy Netflix for like 50 million bucks or something stupid, right? Really cheap. But they laughed them out of the boardroom. It wasn't that many years after that Blockbuster was bankrupt. Now look at Netflix today. 

Jeff Bezos has talked about Amazon. He started from scratch years ago, one of the most successful companies in the world right now, certainly one of the most influential. On a daily basis, we're impacted by lots of different parts of Amazon. But he's even addressed their employees and said, “Amazon will not be around forever. Amazon will not be on top forever, so our job as stewards of the company is to keep it going as long as we can.” I think it's good to know that leadership changes, environments change. So, remember that if people get too emotionally attached to a stock or a piece of real estate or any number of things, they could let confirmation bias keep them from being thoughtful about how they're managing those things.

Jeremy: Yeah, that’s a huge reason to have some kind of financial planner in your life, because the role that a financial planner plays is to be someone who detaches that emotional aspect from the financial aspect. It's easy to sit there and say, “I'm not going to be emotionally attached to my money.” However, we all are to some degree. When you have that professional sitting next to you in a room and showing you what your concentration is in any particular investment, and what the risk involved with it is, then coming up with a plan, a disciplined approach to make sure you're not over-concentrated or that you're not going to become over-concentrated as you continue to work for that company, you have the information you need to make the decisions that fit for you.

Josh: And one of the nice things about working with a Certified Financial Planner is that you know you're working with a fiduciary. A fiduciary is ethically bound to give you advice that's in your best interest. Legally, it's our job to point things out. If there's something we're seeing that maybe is a danger or risk in your portfolio or your financial life, it’s our job to bring that up. And obviously it's your money, right? It's the client's money, your own decisions, what you want to do with your money. But it helps a lot to have that person, that fiduciary, that trusted advisor looking out for you, telling you what they notice. At least maybe it's something to be thoughtful about that you didn't recognize before. 

So instead of just accumulating stock forever, what are things to think about along the way for somebody as their RSUs are vesting, someone who says, “I've got 80% of my net worth in this one company or maybe in only a couple of stocks, how do I manage that?” Iif somebody's got quarterly vesting on their RSUs, what do you tend to see people doing or what's going through their minds each quarter?

Jeremy: What is ultimately the goal of these funds as they come through is to contribute more income to retirement. How do I do that using these strategically? Maybe I want to pay off my house faster, reduce my debt. Those RSUs and the funds coming from those can actually make that happen. It all comes down to planning that cash flow. So, it’s important to know when those vestings are happening, know the tax impacts, and then plan for what to do with that, whether it's more diversification, debt reduction, or some other financial goal you might have.

Josh: Yeah, and in a lot of cases, we find that people are just kind of auto-selling. Most companies don't truly have an automatic way to sell the shares as they vest, but a lot of people sell because they know that they might have millions of dollars of unvested RSUs that are going to be coming in over the years. They know that if their company stock does well, they're going to benefit, but taking that risk off the table along the way and then doing something else with the money can be helpful. Again, it depends on the situation. There's no one-size-fits-all for what you should do based on your own plan. But if your financial house is in order, assuming you've got all your debt paid off and cash in the bank for emergencies, then it probably comes down to your own personal goals. Maybe it's paying off the house early, maybe it's funding college education for a kid or a grandkid, or for other people. Of course, the big one is retirement, having a portfolio that's large enough so you don't have to work anymore.

Jeremy: You see a lot of mistakes that come along with this. One, these can be overwhelming to a lot of people, especially when you're talking about good companies with good RSU programs. As we’ve been saying, we see things like ignoring the tax impact of this, or over-concentration, or just letting the RSUs do their thing and build up. But for those clients who come in, we do have strategies to work with a situation where someone has 60, 70, 80% of their wealth in one stock. There are money managers we can use to help alleviate that and not get killed from a tax standpoint.

Josh: Yeah, there are strategies designed specifically for that concentration risk and the fact that it could be a super low tax basis position with high gains. Sometimes it comes from RSUs, sometimes it’s something else. In some circumstances, we’ve had clients who were gifted shares years ago or inherited them, and they just let them accumulate. Then the stock has been a rocket ship ever since. So, if you've got a lot in one thing, it’s useful to ask, “How do I get out with at least being thoughtful?” 

Sometimes you can't avoid taxes. Sometimes it makes sense just to pay them, right? As a financial planner, I've found that if you let the tax horse drive the cart instead of good thoughtful investments, you may make a decision that doesn't lead you in good directions. We don't want to get overly focused on taxes, but it's an important consideration, especially if you're in a high tax state. If you're very high income, you're in the higher tax brackets. You want to be thoughtful about consequences and know what's happening.

Jeremy: Yeah, I like how you said that. Don't let the tax horse drive the cart. I think we do see that sometimes. Which is understandable. It hurts. But people also have to realize that's a very first world problem. It’s a good problem to have. Paying taxes on this stuff means that something good happened for you in that situation. And as you said, it’s more about planning for the future. Don't live in the tax worry situation, plan for that future, diversify, make sure that if you want to retire at 55, you can.

Josh: Yeah, absolutely. And here at Keystone, we do spend a lot of time on risk. I think in a really good market, people start to forget about risk, just because things are so good. And that confirmation bias kicks in so we think, oh, things are going to be good forever. That's not going to happen. You're going to hit rough markets. Maybe they don’t last long. Maybe it's just a bad day or a bad month. But sometimes, you have a really bad year. It could just be a really bad year for that company's stock or it could be for that sector. It may not be the overall market. Again, thinking back to early 2000s, I remember the people who had well-diversified portfolios and didn't have all their money in tech stocks or telecom, which were the two sectors that got crushed at the time. If you had a bunch of other stuff, say you had energy and consumer goods and a bunch of other stuff in the portfolio, those sectors didn't get hit nearly as hard. So, sometimes the concentration could be in a sector. It could be that you have way too much in one type of company. Then the environment changes or maybe things get way overpriced. 

One other thing I was going to mention too is that as you're thinking about your sales strategy and how you're getting out, it's important to be aware of your own personal circumstances, which I'm sure they've let you know. Say if you've got a certain trading window, meaning you're only allowed to sell during certain times just because the company knows insider information. It's important to be thoughtful about that, especially if you've got really narrow windows when you can sell. That’s an extra risk as far as concentration. You may not be able to move as quickly as other people to sell your stock. 

Another side of this, if you're thinking about company stock as just a part of your benefits. Say, if something drastic happens to your company, your health insurance, your disability insurance, your life insurance, your matching on your 401K, are all tied into your total benefits package. And on top of that, if you've got 80% of your net worth in that company's stock, think about Enron. I mean, that's the poster child for bad outcomes. Back at Enron, that was exactly the situation. A lot of the people in the plan, believe it or not, were allowed to put 100% of their 401k into Enron stock. And when the stock went to zero, everybody lost their jobs along with all those benefits. 

We’re not intending to sit here as naysayers, but we've seen situations, right? We've seen things change and change quickly. Therefore, we want to be really careful. Obviously, this is very situational based off of who you work for, how your plan works, how your vesting works. So many things about your own personal taxes and income and situations that make it advisable to get a CFP, a fiduciary. Yes, we're tooting our horn because that's what we do and we're really good at it. But having somebody in your corner, even if it's not us, finding a true fiduciary can help you manage this stuff. Because for a lot of our clients, it's significant. It could be a huge game-changer as far as your ultimate outcome and your financial security. 

We think this is fun. I mean, we're having conversations like this every day with people. So, remember that there are ways to manage these things we’ve been talking about. I'm not going to get into specifics on strategies, but there are strategies designed for that where we can either greatly minimize taxes or at least minimize them somewhat.

Jeremy: It's super important to have a plan. I think talking to a CFP, someone like us, is probably the best idea because they might be able to see things that you don't see coming. You might be a very intelligent person getting these RSUs but it’s still a good idea to get that third party expertise to weigh in on it and think about things that will help avoid those common mistakes and come up with a plan. It can be a big boon to your financial situation, but if you don't do anything about it, or you make those common mistakes, it can be disastrous.

Josh: Sure can. First world problems, but they are problems, right? These are things that need to be managed softly. With that in mind, if anybody wants to take us up on that, we're always happy to have a conversation. We're not going to charge you for it. Say if you're not a client right now, we offer an ask-me-anything call. That's no charge, no obligation. If you just want to bounce some things off of us, have us look at your situation and get some thoughts, it's a 20-minute call. You can go to our website at www.keystonefinancial.com . You can also e-mail us at communications@keystonefinancial.com and one of us will reach out to you. With that in mind, appreciate your time. I hope you all have a great week and God bless.

We love feedback and we'd love it if you would pass it on to me directly at josh@keystonefinancial.com . Also, please stay plugged in with us, get updates on episodes, and help us promote the podcast by rating us five stars and subscribing to us at Apple Podcasts, Spotify, or your favorite podcast service.

The opinions voiced in the Wiser Financial Advisor show with host Josh Nelson are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine what may be appropriate for you, consult with your attorney, accountant, financial or tax advisor prior to investing. Investment advisory services offered through Keystone Financial Services, an SEC registered investment advisor.