Tips for Managing Restricted Stock Units

Contributed by: Robert Ingram, CFP®

Does your employer offer company stock as part of your compensation package? There are many forms of equity compensation ranging from different types of stock awards to employee stock options (ESO) and employee stock purchase plans (ESPP). Over the last several years, Restricted Stocks Units (RSU) have become one of the most popular alternatives offered by companies. 

 Unlike pure stock awards that grant shares of stock or stock options that provide an employee the right to purchase shares at a predetermined price for a specific period of time, grants of RSUs are not actual shares of stock (yet). An RSU is essentially a promise made by the employer company to deliver to the employee shares of stock or cash payment for the value of stock shares following a vesting schedule. The vesting schedule is often based on a required length of employment, such as a three-year or four-year period, or other company performance goals. The number of units generally corresponds to shares of stock, but the units have no value until the employee receives the corresponding stock shares (or equivalent payment) when they vest.  

 How do RSUs Work? 

Let’s say your employer company grants you 1,000 Restricted Stock Units this year with a grant date of September 1st, and a 4-year vesting schedule under which 25% of the units vest each year as shares of the company’s stock. The following September 1st after the original grant date (one year later) as long as you had continued your employment, the first 25% of your 1,000 RSUs vests as actual company stock shares. Assuming the market value of the stock at the time of vesting is $50 per share, you would have 250 shares of stock worth $12,500. 

 Once the shares have vested and been delivered, you now have ownership rights such as voting rights and rights to dividend payments. You can also choose to hold or to sell the shares from that point. In each subsequent year going forward, the next 25% of your RSUs would vest until the 4th year when the remaining 250 of the 1,000 units vest. 

 One of the first important planning considerations for Restricted Stock Units is their taxation. How are RSUs taxed and how might that impact your tax situation?

 There are three triggering events with RSUs to understand.

 When You Receive RSU Grants

In most cases, at the time you receive your RSU grants, there are no tax implications. Because there is no transfer of actual property by the company until vesting in the form of shares or cash payment, the IRS does not consider the value of the stock represented by RSUs as income compensation when the grant occurs. This means the RSU grants themselves are not taxed.

 When RSUs Vest 

 Once the restricted units vest and the employer delivers the shares of stock or equivalent cash payment, the fair market value of the vested shares or cash payment as of that date (minus any amount the employee had to pay for the RSUs) is considered income and is taxed as ordinary income. Typically, companies grant RSUs without the employee paying a portion, so the full value of the vested shares would be reported as income.  

 In our example above with the 1,000 RSU grants, 250 RSUs vested with the fair market value of $50 per share for a total value of $12,500. This $12,500 would be considered compensation and would be reportable as ordinary income for that tax year. This would apply to the remaining RSUs in the years that they vest. Because this amount is treated as ordinary income, the applicable tax rate under the federal income tax brackets would apply (as well as applicable state income taxes).  

 To cover the tax withholding for this reported income at vesting, most companies allow you a few options. These may include:

• Having the number of shares withheld to cover the equivalent dollar amount

• Selling shares to provide the proceeds for the withholding amount

• Providing a cash payment into the plan to cover the withholding

When You Sell Shares 

 At the time RSUs vest, the market value of those shares is reported as ordinary income. That per-share value then becomes the new cost basis for that group of shares. If you immediately sell the vested shares as of the vesting date, there would be no additional tax. The value of the shares has already been taxed as ordinary income, and the sale price of the shares would equal the cost basis of the shares (no additional gain or loss).

 If however, you choose to hold the shares and sell them in the future, any difference between the sale price and the cost basis would be a capital gain or capital loss depending on whether the sale price was greater than or less than the cost basis.  

 Once again using our example of the 1,000 RSU grants, let’s assume the fair market value of 250 shares at vesting was $50 per share and that you held those shares for over one year. If you then sold the 250 shares for $75 per share, you would have a capital gain of $25 per share ($75 - $50) for a total of $6,250. Since you held the shares for more than one year from the vesting date, this $6,250 would be taxed as a long-term capital gain and subject to the long-term capital gains tax rate of either 0%, 15%, or 20% (as of 2021) depending on your total taxable income. 

 If you were to sell shares within one year of their vesting date, any capital gain would be a short-term capital gain taxed as ordinary income. Since the federal tax brackets apply to ordinary income, you may pay a higher tax rate on the short-term capital gain than you would on a long-term gain even at the highest long-term capital gains rate of 20% (depending on where your income falls within the tax brackets).

 Planning for Additional Income

Because Restricted Stock Units can add to your taxable income (as the units vest and potentially when you sell shares), there are some strategies you may consider to help offset the extra taxable income in those years. For individuals and couples in higher tax brackets, this can be an especially important planning item.  

Some examples could include:

• Maximizing your pre-tax contributions to your 401k, 403(b), or other retirement accounts. If you or your spouse are not yet contributing to the full annual maximum, this can be a great opportunity. ($19,500 in 2021 plus an extra $6,500 “catch up” for age 50 and above). In some cases, if cash flow is tight, it could even make sense to sell a portion of vested RSUs to replace the income going to the extra contributions.

• Contributions to a Health Savings Account (HSA) are pre-tax/tax-deductible, so each dollar contributed reduces your taxable income. If you have a qualifying high deductible health plan, consider funding an HSA up to the annual maximum ($3,600 for individuals/$,7,200 for family coverage, plus an extra $1,000 “catch up for age 55 and above)

 Deferred Compensation plans (if available) could be an option. Many executive compensation packages offer types of deferred compensation plans. By participating, you generally defer a portion of your income into a plan with the promise that the plan will pay the balance to you in the future. The amount you defer each year does not count towards your income that year. These funds can grow through different investment options, and you select how and when the balance in the plan pays out to you, based on the individual plan rules. While this can be an effective way to reduce current income and build another savings asset, there are many factors to consider before participating. 

• Plans can be complex, often less flexible than other savings vehicles, and dependent on the financial strength and commitment of the employer.

• Harvesting capital losses in a regular, taxable investment account can also be a good tax management strategy. By selling investment holdings that have a loss, those capital losses offset realized capital gains. In addition, if there are any remaining excess losses after offsetting gains, you can then offset up to $3,000 of ordinary income per year. Any excess losses above the $3,000 can be carried over to the following tax year.

 When Should I Sell RSUs?

 The factors in the decision to sell or to hold RSUs that have vested as shares (in addition to tax considerations) should be similar to factors you would consider for other individual stocks or investment securities. A question to ask yourself is whether you would choose to invest your own money in the company stock or some other investment. You should consider the fundamentals of the business. Is it a growing business with good prospects within its industry? Is it in a strong financial position; or is it burdened by excessive debt? Consider the valuation of the company. Is the stock price high or low compared to the company’s earnings and cash flow?

Consider what percentage of your investments and net worth the company stock represents. Having too high a concentration of your wealth in a single security poses the risk of significant loss if the stock price falls. Not only are you taking on overall market risk, but you also have the risk of the single company. While each situation is unique, we generally recommend that your percentage of company stock not exceed 10% of your investment assets.

You should also consider your financial needs both short-term and long-term. 

Do you have cash expenses you need to fund in the next year or two and do you already have resources set aside? 

If you’re counting on proceeds from your RSUs, it could make sense to sell shares and protect the cash needed rather than risk selling shares when the value may be lower.  

 As you can see, equity compensation and specifically RSUs can affect different parts of your financial plan and can involve so many variables. That’s why it’s critical that you work with your financial and tax advisors when making these more complex planning decisions. 

So please don’t hesitate to reach out if we can be a resource.

Robert Ingram, CFP®, is a CERTIFIED FINANCIAL PLANNER™ professional at Center for Financial Planning, Inc.® With more than 15 years of industry experience, he is a trusted source for local media outlets and frequent contributor to The Center’s “Money Centered” blog.

Disclosure: While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional.

The Single Most Important Investing Decision

Contributed by: Nicholas Boguth

Unsurprisingly, I think investing is fun. This is one of the reasons I’ve chosen a career in investment management. With that being said, my career is only 6 years in. Is it possible that I only think investing is fun because the stock market has hit a new all‐time high every single year of my career? Do stocks ever fall? Why even own bonds that pay 2% coupons?

With the decade being over, and the S&P 500 rising almost 190% over the prior ten years, it seems like a good time to remind ourselves of a few key investing principles.

• Stocks are risky. Their prices can fall.

• Bonds are boring, but they have potential to help preserve your portfolio.

• Asset allocation is the single most important investing decision you will make.

Asset allocation in its simplest form is the ratio of stocks to bonds in your portfolio. More stocks in your portfolio means more risk. More bonds in your portfolio means more potential to balance out the risk of stocks. As financial planners, one of the first decisions we’ll help you make is the decision of what asset allocation is most likely going to lead to your financial success.

Take a look at the drawdowns of a portfolio of mostly stocks (green line) compared to a portfolio of mostly bonds (blue line). Stocks may have roared through the 2010’s, but no one has a crystal ball to tell us what they will do in the 2020’s. This chart is a good reminder of what stocks CAN do. Be sure that your portfolio is set up to maximize your chance of success no matter what stocks do. If you are unsure about your current portfolio, we’re here to help.

Source: Morningstar Direct. Stock index: S&P 500 TR (monthly). Bond Index: IA SBBI US IT Govt Bond TR (monthly).

Nicholas Boguth is a Portfolio Administrator at Center for Financial Planning, Inc.® He performs investment research and assists with the management of client portfolios.

---

Investing involves risk and you may incur a profit or loss regardless of strategy selected, including diversification and asset allocation.

The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. The IA SBBI US IT Government Bond Index is an index created by Ibbotson Associates designed to track the total return of intermediate maturity US Treasury debt securities. One cannot invest directly in an index. Past Performance does not guarantee future results.

Restricted Stock Units vs. Employee Stock Options

Contributed by: Kali Hassinger, CFP®

Some of you may be familiar with the blanket term "stock options." In the past, this term most likely referred to Employee Stock Options (ESOs), which were frequently offered as an employee benefit and form of compensation. But over time, employers have adapted stock options to better benefit both their employees and themselves.

ESOs provided the employee the right to buy a certain number of company shares at a predetermined price, for a specific period of time. These options, however, would lose their value if the stock price dropped below the predetermined price, making them essentially worthless to the employee.

Shares promised

As an alternative, many employers now use another type of stock option, known as Restricted Stock Units (RSUs). Referred to as a "full value stock grant,” RSUs are worth the "full value" of the stock shares when the grant vests. So unlike ESOs, the RSU will always have value to the employee upon vesting (assuming the stock price doesn't reach $0). In this sense, the RSU is a greater advantage to the employee than the ESO.

As opposed to some other types of stock options, the employer does not transfer stock ownership or allocate any outstanding stock to the employee until the predetermined RSU vesting date. The shares granted with RSUs essentially become a promise between the employer and employee, but the employee receives no shares until vesting.

RSU tax implications

Since there is no "constructive receipt" (IRS term!) of the shares, the benefit is not taxed until vesting.

For example, if an employer grants 5,000 shares of company stock to an employee as an RSU, the employee won't be sure of how much the grant is worth until vesting. If this stock value is $25 upon vesting, the employee would have $125,000 of income (reported on their W-2) that year.

As you can imagine, vesting dates may cause a large jump in taxable income, so the employee may have to select how to withhold taxes. Usual options include paying cash, selling or holding back shares within the grant to cover taxes, or selling all shares and withholding cash from the proceeds.

In some RSU plan structures, the employee may defer receipt of the shares after vesting, in order to avoid income taxes during high earning years. In most cases, however, the employee will still have to pay Social Security and Medicare taxes in the year the grant vests.

Although there are a few differences between the old-school stock options and more recent Restricted Stock Unit benefit, both can provide the same incentive for employees. If you have any questions about your own stock options, we’re always here to help!

Repurposed from this 2016 blog: Restricted Stock Units vs Employee Stock Options

Kali Hassinger, CFP® is an Associate Financial Planner at Center for Financial Planning, Inc.®

---

The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any opinions are those of Kali Hassinger, CFP® and not necessarily those of Raymond James. Expressions of opinion are as of this date and are subject to change without notice. There is no guarantee that these statements, opinions or forecasts provided herein will prove to be correct. Investing involves risk and you may incur a profit or loss regardless of strategy selected. This information is not intended as a solicitation or an offer to buy or sell any security referred to herein. Investments mentioned may not be suitable for all investors. This is a hypothetical example for illustration purpose only and does not represent an actual investment.

Unpacking Incentive Stock Options

Contributed by: Matt Trujillo, CFP®

What is an ISO?!

Some of you reading this might have been granted Incentive Stock Options (ISOs) in the past or perhaps this is something that your employer recently started to grant you. In either case it never hurts to get a refresher on what they are and some of the nuanced planning opportunities that go with them. ISOs are a form of stock option that employers can grant to employees often to reward employees' performance, encourage longevity with the company, and give employees a stake in the company's success. A stock option is a right to buy a specified number of the company's shares at a specified price for a certain period of time. ISOs are also known as qualified or statutory stock options because they must conform to specific requirements under the tax laws to qualify for preferential tax treatment.

The tax law requirements for ISOs include*:

• The strike price—the price you will pay to purchase the shares—must be at least equal to the stock's fair market value on the date the option is issued.

• To receive options, you must be an employee of the issuing company.

• The exercise date cannot be more than 10 years after the grant.

*Special rules may also apply if you own more than 10 percent of your employer's stock (by vote). Nonqualified stock options, another type of employee stock option, are separate from ISOs therefore receive different tax treatment.

Once you have been granted a stock option, you can buy the stock at the strike price even if the value of the stock has increased. If you choose to exercise a stock option, you must buy the stock within the specific time frame that was set when the option was purchased or granted to you. You are not required to exercise a stock option.

Your options may be subject to a vesting schedule developed by the company. Unvested options cannot be exercised until some date in the future, which often is tied to your continued employment. The stock that you receive upon exercise of an option may also be subject to a vesting schedule.

Assuming that a stock option satisfies the tax law requirements for an ISO, preferential tax treatment will be available for the sale of the stock acquired upon the exercise of the ISO, but only if the stock is held for a minimum holding period. The holding period determines if a sale of the stock you received through the exercise of an ISO is subject to taxation as ordinary income or as capital gain or loss.

To receive long-term capital gain treatment, you must hold the shares you acquired upon exercise of the option for at least:

• Two years from the date you were granted the option, and

• At least one year after the date that you exercised the option

So whether this is something new to you or something you’ve been handling for a long time, feel free to contact us with questions regarding the nuances around Incentive Stock Options.

Matthew Trujillo, CFP®, is a Certified Financial Planner™ at Center for Financial Planning, Inc.® Matt currently assists Center planners and clients, and is a contributor to Money Centered.

---

This information does not purport to be a complete description of Incentive Stock Options, this information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Investing in stocks always involves risk, including the possibility of losing one's entire investment. Specific tax matters should be discussed with a tax professional.

Investor Basics: Stocks 101

Contributed by: Nicholas Boguth

Earlier in the Investor Basics series, we went over the basics of bonds. Now we’re going to switch gears to the equity side of the investment universe, and gain a better understanding of the basics of stocks.

What is a stock?

A stock is a claim on a company’s assets, or in other words, a share in ownership. If you own a stock, then you own a piece of the company.

The major difference between stocks and bonds is that bonds have a contractual agreement to pay interest until the bond retires, while owners of stocks have a claim to assets so they hope to make money on capital or price appreciation and/or dividend income. Another major difference between stocks and bonds is that owners of stocks do not get paid in the event of a company’s bankruptcy until after all the bond holders are paid. For these reasons, stocks are typically considered “more volatile” investments.

What are the different types of stock?

There are two main types of stocks – common and preferred.

When hearing people talk about stocks in everyday conversation, it is usually safe to assume that they are talking about common stock. Common stocks are much more prevalent in the market. The major difference in characteristics of common stocks and preferred stocks are – 1. Common stocks do not have a fixed dividend, while preferred stocks do, and 2. Common stocks allow the investor to vote on corporate matters such as who makes up the board of directors, while preferred stocks do not.

Voting rights depend on the number of shares that you own. If you own 1000 shares, you have 1000 votes to cast. Most companies allow votes to be cast by proxy, so the individual investor does not have to be present at things like annual meetings in order to cast a vote. Proxy votes can typically be sent in by mail, or nowadays it is common that you will be alerted via email that you are able to vote on a company’s policy and you may cast it quickly online.

Preferred stocks may not allow the investor to vote on policies, but they do have a fixed dividend that is typically higher than the dividend of a common stock, and in the event of liquidation will be paid before common shareholders (but after bond holders). You may note that a fixed dividend sounds a lot like the fixed interest payment of a bond. This is true, but there is no contractual obligation to pay the dividend on stocks. These similarities typically make preferred shares act like something in between a stock and a bond – something that does not participate in the price movement of a company as much as a common stock, but receives a fixed dividend similar to the interest payment of a bond.

Nicholas Boguth is an Investment Research Associate at Center for Financial Planning, Inc. and an Investment Representative with Raymond James Financial Services.

---

This information does not purport to be a complete description of the securities referred to in this material, it is not intended as a solicitation or an offer to buy or sell any security referred to herein. Investments mentioned may not be suitable for all investors. Investing in common stocks always involves risk, including the possibility of losing one's entire investment. Dividends are subject to change and are not guaranteed, dividends must be authorized by a company's board of directors.

What You Need to Know about Stock Options

Contributed by: Nick Defenthaler, CFP®

As a professional, there are various ways you can be compensated for your work.  Although not as prevalent as they once were, stock options still exist in many different companies and can often be negotiated into your overall compensation package.  Stock options are intended to give you motivation and incentive to perform at a high level to help increase the company’s stock price which will, in turn, have a positive impact on the value of your own stock options.  There are various forms of stock options and they can certainly be confusing and even intimidating.  If you’ve ever been offered options, your initial thought might have been, “I know these things can be great, but I really don’t have a clue what they are or know what to do with them!” For starters, there are two common forms of stock options NSOs & RSUs.

NSO: Non-qualified Stock Options

Non-qualified stock options, or NSOs, have been around and very popular for decades.  The mechanics, however, can be a bit tricky which is partly why you don’t see them quite as much as you used to.  There are various components to NSOs, but to keep things simple, the company’s stock price must rise above a certain price before your options have value.  Taxes are typically due on the difference between the market value of the stock upon “exercising” the stock option and what the stock price was when the option was “granted” to you.  Upside potential for NSOs can be significant but there’s also a downside. The options could expire making the stock worthless if it does not rise above a certain price during the specified time frame.

RSU: Restricted Stock Units

Restricted Stock Units, or RSUs, have become increasingly popular over the past 5 – 10 years and are now being used in place of or in conjunction with NSOs because they are a little more black and white.  Many feel that RSUs are far easier to manage and are a more “conservative” form of employee stock option compared to NSOs because the RSU will always have value, unless the underlying company stock goes to $0.  As the employee, you do not have to decide when to “exercise” the option like you would with an NSO.  When the RSUs “vest”, the value of the stock at that time is available to you (either in the form of cash or actual shares) and is then taxable.  Because you do not truly have any control over the exercising of the RSU, it makes it easier and less stressful for you during the vesting period.  However, because the RSUs vest when they vest, it does take away the opportunity to do the kind of pro-active planning available with NSOs.

Stock Options and Tax Planning

As you can see, stock options have some moving parts and can be tough to understand.  There are many other factors that go into analyzing stock options for our clients and we typically also like to coordinate with other experts, like your CPA because tax planning also plays a large part in stock option planning. If stock options are a part of your compensation package, it is imperative to have a plan and make the most of them because they can be extremely lucrative, depending on company performance and pro-active planning.  Please reach out if you ever have questions about your stock options – we work with many clients who own them and would be happy to help you as well!

Nick Defenthaler, CFP® is a CERTIFIED FINANCIAL PLANNER™ at Center for Financial Planning, Inc. Nick is a member of The Center’s financial planning department and also works closely with Center clients. In addition, Nick is a frequent contributor to the firm’s blogs.

---

US Stocks & the Federal Reserve - 2nd Quarter 2012

As the saying goes, “Don’t fight the Fed!” Many investment experts have noted the strong relationship between the market’s ups and downs and Federal Reserve policy. This chart, compiled by Doug Short at dshort.com beautifully illustrates the relationship between Fed intervention programs and the S&P 500. 

While Operation Twist is scheduled to end in June 2012, Federal Reserve board members have also started to use stated future targets for interest rates as a means to encourage market participants to invest in stocks. As recently as April 11th, Fed Vice Chair Janet Yellen indicated that the Fed’s “Zero Interest Rate Policy” could remain even past the initial 2014 target date. If markets stumble, some think that a third round of Quantitative Easing may also be possible.

There will come a time when markets need to stand on their own two feet. Based upon the words and deeds of the Fed, those days may be several years away.

Hat Tip: The Big Picture, Barry Ritholtz.

U.S. Stocks - 1st Quarter 2012

Last year the S&P 500 – a bell-weather for American stocks – was statistically unchanged from a price perspective.  When you add in dividends, the index was up 2%.  You may be feeling a lot more bumps and bruises from the year in stocks than a flat 12-month return would indicate.  Markets had wild swings and Ron Griess of the Chart Store (Hat Tip ritholtz.com) reports that 2011 was the seventeenth most volatile year for the S&P 500 since 1928.  Perhaps not surprisingly, 2008 and 2009 were even more volatile.  All of this has presented a behavioral challenge for investors with the temptation to time the market or get off the bumpy ride.

As with anything, it is very difficult to predict volatility.  It’s best to plan, though, for more ups and downs.  Volatility seems to come in patches with 15 of the 17 most volatile years for the S&P coming between 1929 and 1939 or between 2000 and 2011.  Managing your investment behavior through allocation planning, regular rebalancing, or the advice of an investment professional is critical to help avoid paralysis or bad timing.

Returns of large US companies surged ahead of their smaller peers. While large company S&P returned 2%, the Russell 2000, a common index for small companies, was down 4%.  The Dow Jones Industrial Average, even bigger than the S&P as measured by market capitalization, returned 8%.  Still, smaller stocks have outpaced large stocks cumulatively since March 2009 (when using the same indexes).

Many have watched for large companies to outperform due to compelling valuations and diversified revenue sources.  This trend may continue with strong profit margins, cash on the books, and still interesting valuations relative to larger stocks.

Dividend-paying companies, especially those outside of the financial sector, rewarded their investors handsomely in 2011.   Dividends fulfilled their promise last year helping both the total return of companies as well as raising interest from investors for their companies themselves.

We still like dividends for reasons Angie Palacios, CFP® I explained in a recent blog post.  Dividend yields are attractive relative to interest that bonds pay across the world.  Furthermore, as more boomers retire and seek a more steady income stream (no small feat in a low-yield world), a strategy that includes dividends may remain attractive relative to their cash-hoarding peers. *Dividends are not guaranteed and must be authorized by a company’s board of directors.