We dive into the world of Restricted Stock Units (RSUs) in this episode, focusing on their role in equity compensation for tech professionals. RSUs are a form of stock option that grants ownership in a company's stock once vested, according to a predetermined schedule. This vesting schedule is crucial for employees to understand as it impacts their overall financial planning, including tax implications. RSUs are taxed as ordinary income upon vesting, similar to a paycheck, necessitating careful tax planning to manage potential liabilities.
Amy highlights the importance of being forward-looking in financial planning, contrasting with the backward-looking nature of tax preparation by CPAs. She advises setting aside a portion of RSUs or their proceeds to cover taxes, ensuring no surprises come tax time. Employers typically withhold a portion of the vested shares to cover federal taxes, with the remaining shares transferred to the employee's brokerage account, which can then be liquidated or managed according to the employee's financial strategy.
Success stories, like that of "Sarah," illustrate how effectively managing RSUs can significantly contribute to wealth building and achieving financial independence. By strategically selling vested shares to diversify investments, tech professionals can leverage RSUs as a cornerstone of their financial planning. However, it's crucial to avoid common misconceptions and pitfalls, such as the belief that holding RSU-derived shares for over a year qualifies them for preferential capital gains tax rates. In reality, RSUs are taxed as income upon vesting, and any decision to hold shares longer is akin to purchasing employer stock directly, with all associated risks.
Understanding RSUs' role in compensation and wealth building, while navigating their tax implications and avoiding common pitfalls, is essential for tech professionals looking to maximize their financial potential. Engaging with a financial professional can provide valuable guidance in managing RSUs effectively as part of a broader financial strategy.
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Jon: Welcome back to ThimbleberryU. I am Jon "JAG" Gay, joined as always in Fresh Off the Slopes by Amy Walsh of Thimbleberry Financial. Amy, great to be with you.
Amy: Jag, it's great to be here.
Jon: Today's the third part in our six-part series for tech professionals. Today we're talking about RSUs. RSUs, those restricted stock units, we've hit on these in many of our previous hundred or so episodes, Amy, but we're going to do a deep dive today, right?
Amy: We are. Today we're going to talk, like you said, about RSUs, which are another essential component of that equity compensation package. Unlike the ESPPs that we talked about recently, RSUs, restricted stock units, grant you ownership in your company's stock once those shares vest. Vesting schedules, so there's a certain pattern that the company tells you when they grant you these. That is your vesting schedule dictate when these RSUs, when the shares, because they're no longer RSUs when they vest, become yours. That's normally over a set period of time.
Really, we have to think about what's the purpose. Really, the purpose is that structure of vesting over time can encourage long-term commitment from employees and aligns our listeners' interests, if they have these with the company's success. I think, as we talk about this today, what is essential for our listeners is that they need to understand that vesting schedule and plan accordingly as it impacts their entire financial picture.
Jon: Absolutely. Of course, part of that financial picture is tax considerations. Can you shed light on the tax implications and how tech executives can manage them efficiently when it comes to these RSUs?
Amy: Absolutely, Jag. RSUs are typically taxed as ordinary income when they vest. Same way that we earn money on a paycheck. Tech professionals need to be able to plan for that tax liability. Now, the good news is you rarely get RSUs that are going to vest right after they've been given to you. Okay. There's going to be some waiting period. Come December 31st of any year, you could probably look ahead to the next year and be able to see, I have this many shares that are going to vest at these points over the calendar year. Given, a variety of share prices or current share price, you have a pretty good idea of what that income's going to be from a tax planning standpoint.
Jon: Let me stop you right there, Amy, because I think that's something that we've hit on a previous podcast. somebody like a CPA, when it comes to taxes, they're looking backward at the previous year. A financial professional like you, you're looking forward and planning for these types of things, exactly like you just said.
Amy: Absolutely. There is that distinct difference in the forward looking, versus the past looking. It actually can be a little bit tricky for us to piece together what has happened in the past. Whereas, the CPA is going to get it on the tax forms at the end of the year. As we look at taxes, though, what we want to look at is strategy and how to use these shares efficiently. One of those strategies is to set aside a portion of the RSUs, the stock and the proceeds, the cash, essentially, to cover taxes when they vest, so that someone won't be caught off guard.
Let's explain how that works. Jag, you get RSUs and March 15th, they are going to vest. Right now, because it's not March 15th yet, they are restricted stock units. On March 15th, when they vest, and let's just say it's 100 shares that will be vesting.
Jon: Nice easy number.
Amy: Yes. I'm all for that. 100 shares vest, you no longer have RSUs, or at least those 100 shares are not. You may have a stash that still haven't vested.
Jon: They used to be RSUs. They've now vested. Once they vest, they have now become stocks, not RSUs.
Amy: Correct. Some companies also allow something called a quick sale, which means you can say ahead of time that when my shares vest, I actually just want them turned to cash. These 100 shares vest, what's going to happen is your employer is going to have to withhold a certain number of shares to cover the tax bill. Now, that tax bill isn't based on your withholding rate of your regular salary. On RSUs, it is 22% for federal, until you have had $1 million vest in the year.
Jon: I would imagine in most cases, that's not common.
Amy: Correct. That is not common. Now, some employers you can actually ask to have the higher rate withheld, but typically it's going to be 22%. Therefore, of those 100 shares, you are going to have 78, 100 minus 22 that they're withholding. You're going to have 78 transferred into a brokerage account that then you could liquidate.
Jon: The employer is covering the taxes on this upfront?
Amy: The employer's not covering them. They're withholding them from your proceeds, to withhold part of your tax bill so you don't get hit as badly at tax time.
Jon: Let me rephrase that. Then the employer is facilitating you paying the taxes on it. How about that?
Amy: That is a great way of saying.
Jon: I'd imagine, Amy, you've got some real life success stories to share among your clients where tech professionals effectively utilized these RSUs to enhance their wealth building?
Amy: Absolutely. Someone that comes to mind, we'll call Sarah. She received RSUs as part of her compensation package, obviously. Over time, as her RSUs vested, Sarah strategically sold shares to diversify her investments and fund her future. Basically, she used it as retirement assets, if you will, or assets towards financial independence. While she hasn't pulled the plug yet, she's now on track to be financially independent before age 55.
Jon: Wow.
Amy: Because she's saving for retirement. She's using these assets to help supplement and give her flexibility to retire earlier than most people will. Really, if we look at it, her RSUs played a pivotal role in her wealth building journey and provided her a means to achieve those goals while also benefiting from her company's success.
Jon: Got you. I'm sure you regret calling her Sarah because the sentence earlier of Sarah strategically sold shares is akin to Sally sells seashells by the seashore.
Amy: [laughs] Yes.
Jon: All right, let's move on. How can tech executives view RSUs as a valuable tool in their wealth building arsenal?
Amy: You're right. These are a valuable tool. For a lot of people, they can serve as a cornerstone of the wealth building strategy. When they understand their vesting schedule and how to manage the tax implications, that's really where you can harness this full potential. It comes from being prepared for those taxes, having an opportunity to accumulate assets, taking advantage of that opportunity to accumulate assets, but doing it in a safe way.
Taking these shares and selling them and then diversifying into a portfolio, rather than saying, I'm just going to continue to hold shares of my company stock to not pay a tax bill. We already know there was a tax bill. Let's take those shares, use them to diversify and build a portfolio that's going to support the long term goals. That's financial independence or retirement or funding a dream home, as the case may be.
Jon: I want to put a final point on what you just said, because we talk about diversification and not putting all your eggs in one basket financially here. The RSUs are such a great tool, but if they cause you to be weighted too heavily in your employer's stock because you've got too much of your investment there, not to mention it's where your paycheck is coming from. That can be a very dangerous situation depending on the individual. I'm glad you said that if you are going to sell them, it's great to diversify and keep on track with your overall financial plan.
Amy: I'm glad you brought that up. It's really important to remember that. I think there's a flip side to that that's almost just as dangerous.
Jon: Which is?
Amy: That somebody plans on these being for their future, but they don't have a good systematic way, disciplined way of capturing the proceeds when they go to sell to diversify and these just continually become part of their lifestyle.
Jon: Again, another reason to have a unbiased financial professional to work with. We'll come back to your contact information in a minute. One of your favorite things to say in this podcast, Amy, is for every give you, there's a got you. We would be remiss if we did not hit on the gotchas, the flip side of these RSUs.
Amy: There are some. [laughs] First one that comes to mind is that you need to hold shares. Let me clarify. The gotcha is really more of a misconception, but I hear it so often that I would classify it as a gotcha. That is the misconception that you need to hold shares that came from RSUs more than a year to get the preferential capital gains taxed rate. It's not true.
Why I say that is RSUs in and of themselves, do not have a preferential tax rate. It's not attached to them. It is attached to stock. But because when these vest, they are taxed the same way as your salary is, you are essentially by holding them, choosing to buy employer stock with the proceeds from your paycheck.
Jon: I see.
Amy: So there is no one year for a preferred tax rate, as it relates to the RSUs. It does relate to the stock, so if March 15th, you have shares vest and you don't sell that stock, and the price goes up wildly in eight months and you're thinking about selling, well, now if you sell at that point, you aren't going to get preferential tax rates. You would need to wait one year and one day from March 15th, in order to sell and get preferential rates, but it doesn't have to do with the vesting.
Jon: Okay, thank you for clarifying that. What else do you have for gotchas?
Amy: I alluded to this, but forgetting what the stock shares are. They are compensation from your employer, plain and simple. That's what they are. That compensation, they're promising to you when the shares vest. There is no compensation before these shares vest. They don't have value. There's zero compensation. There's a promise of future compensation. That compensation will be taxed when they vest. Obviously, I'm using the word taxed a lot in this podcast.
Jon: Sure.
Amy: As I mentioned, holding the shares is equivalent to buying your employer's stock with your paycheck. In some cases there's really good reasons to do that. In some cases there are really good reasons not to do that. The gotcha is forgetting what those shares actually are, because people often get attached to, "Well, they gave me these shares when the stock price was $80, and the stock price has been $20 for the last two or three years. I can't sell them until they're $80."
Jon: It's got to come up, it's got to come up. I keep playing this roulette wheel. Eventually it's going to come up black.
Amy: Yes, it's believing that you were compensated at $80 a share. You weren't because it's zero compensation until the time they vest.
Jon: Lots of biases come in there for sure. I'm glad you mentioned that. It really speaks to working with an expert in this space. With that in mind, I know you do a lot of work in this space, Amy. If somebody wants to come talk to you and your team at Thimbleberry Financial, what are the best ways to find you?
Amy: They can find us at thimbleberryfinancial.com or by giving us a call at 503-610-6510.
Jon: Excellent stuff, Amy. We'll talk again in a couple of weeks.
Amy: Sounds wonderful. Thanks.
Jon: Securities offered through registered representatives of the Cambridge Investment Research, Inc., a broker dealer member FINRA SIPC, advisory services through Cambridge Investment Research Advisors, Inc., a registered investment advisor. Cambridge and Thimbleberry Financial are not affiliated. Discussions in this show should not be construed as specific recommendations or investment advice. Always consult with your investment professional before making important investment decisions.
Securities offered through registered representatives of Cambridge Investment Research, Inc., a broker dealer member FINRA SIPC, advisory services through Cambridge Investment Research Advisors, Inc., a registered investment advisor. Cambridge and Thimbleberry Financial are not affiliated.
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