If your company has granted you restricted stock units (RSUs) subject to a timed vesting schedule, then periodically you’ll need to decide what to do with the vested shares you receive.
What you do with those shares is important for your long-term financial planning, particularly if the cumulative value of the shares represents an appreciable portion of your net worth. The relevant considerations are whether you should keep the shares and, if not, when to sell them.
In the majority of cases, it’s best to sell your vested RSU shares as you receive them and add the proceeds to your well-diversified investment portfolio. Of course, there are exceptions. We’ll look at both scenarios.
RSUs are a form of equity compensation that companies provide their employees to align employee interests with shareholder interests and to help attract and retain top talent. On top of salary or wages, this extra income in the form of company stock can represent a significant percentage of an employee’s total compensation. For a quick refresher on RSUs and how they work, take a look at an earlier article, “An Introduction to Restricted Stock and RSUs.”
From an employee’s perspective, once vested RSU shares are received and can be converted to cash through selling the shares, the RSU as a compensation mechanism has served its purpose. The extra compensation is received and is taxed as ordinary income (more on this below).
The fact that compensation is received in the form of stock, and not cash, isn’t particularly relevant because shares of publicly traded companies—the most common with RSUs—can be converted to cash at any time. After receiving RSU shares, the choice to continue to hold the shares or sell them is purely an investment decision.
Evaluating RSU Shares as an Investment
In evaluating RSU shares as an investment, consider how they fit into your existing investment program. If your investment portfolio is prudently built on well-thought-out asset allocation and implemented using diversified investment products (e.g., mutual funds or exchange-traded funds), then loading up on a single stock defeats the purpose of your portfolio’s construction and reduces its diversification.
One of the key goals of diversification is to reduce company-specific risk so poor performance by any one company won’t drastically impact your overall investment performance. Holding RSU shares reduces diversification and increases the risk of your investments. If your goal is to maintain diversification, selling RSU shares when you receive them might be a smart strategy.
The higher the percentage ratio of RSUs compared with your investment portfolio and total net worth, the more important it is to sell those shares and maintain diversification. Holding a large amount of your company’s stock results in a “concentrated position,” which can be severely detrimental if the company’s stock unexpectedly loses value and substantially reduces your net worth.
If your RSU shares are worth $5,000 and your net worth is 1,000 times that amount, then holding the shares for fun isn’t really a concern. But if the value of your RSU shares—potentially combined with the value of other equity compensation such as stock options—exceeds 10% of your net worth, you’ll need to think about reducing your exposure to that single stock.
You may have additional exposure to your employer’s stock if you have significant value in unvested RSU shares that you will receive over time. Those unvested shares may represent a significant portion of your net worth. The more unvested RSUs you have, the higher your continued risk (and upside), and stronger the argument for selling vested RSU shares when you receive them.
The same is true for the value of vested or unvested stock options, restricted stock, employee stock purchase plan (ESPP) shares, or other forms of equity compensation. When taken together with RSUs, the total value from all sources should be less than 10–20% of your net worth as a long-term maximum.
You also have ongoing exposure to your company’s performance because you receive your salary or wages from the company. By selling your RSU shares as they vest, you protect yourself from unexpected deterioration in company performance, which could impact your employment and earnings, and the value of your remaining unvested company stock and options.
Another way to frame the decision of whether to hold vested RSU shares: Consider if you would buy those same shares today on the open market. Quite often, the answer is no. If you wouldn’t go out of your way to buy the shares, you probably don’t have strong enough conviction to warrant holding them either, given the additional exposure to risk.
No Tax Reason to Hold RSU Shares
There is likewise no tax reason to hold RSU shares after the vesting date, because RSUs are taxed as they vest. The units are exchanged for actual shares of company stock and delivered to an employee’s account at the stock plan administrator (usually a brokerage firm such as E*TRADE, Fidelity Investments, or Morgan Stanley).
The value of the shares is taxed as ordinary income for federal and state income tax purposes, and both the income earned and tax withheld from the shares are shown on your paystub and Form W-2 at year-end. The value of the vested shares is also subject to payroll tax, which pays for Social Security and Medicare programs. Other state and local taxes may apply—for example, State Disability Insurance (SDI) in California.
The value of RSU shares is taxed the same as regular salary or wages, with one exception. The employer will withhold federal and state income tax on RSU income at the mandatory “supplemental” withholding rates, which are different from regular income tax withholding rates. As a consequence, the amount of income tax withheld on RSU income will be different than the amount withheld on regular income. Be aware of this difference in your tax planning throughout the year.
When you sell the shares, you will pay capital gains tax on any appreciation of the market value from the vesting date when you received the RSU shares. If you sell the shares immediately, before they increase or decrease in value, there will be no capital gains tax due.
Unlike with incentive stock option (ISO) or employee stock purchase plan (ESPP) shares, there is no special holding period rule that can reduce your tax bill for RSU shares. If you do hold the shares, then they will be taxed exactly as if you had purchased them on the open market on the day they vested.
Exceptions to the Rule of Selling Shares
Generally, investment and tax considerations argue for selling RSU shares immediately or soon after you receive them. However, there may be circumstances when you will need or want to hold your shares.
You may be required to wait until the next time your company’s “trading window” is open before you can sell your shares, which may be a few days to a few weeks. If you are considered a company insider or possess material non-public information about the company, you may need to hold your RSU shares (and other shares of company stock) until you are no longer in danger of violating insider-trading laws.
If you are at risk for charges of insider trading, you might consider putting in place an SEC Rule 10b5-1 trading plan, which helps avoid legal issues. Consult with your company’s compliance officer or a securities attorney if you have any questions in this area.
You may also decide to hold the shares if you believe the company’s stock price will increase, particularly over the short term. Because of your familiarity with the technology, customer needs, competitive landscape, market dynamics, or other factors within the industry your company operates, you may have unique insight into the short-term or long-term performance of the company.
If you believe your insights are more accurate than those of other stock market participants, including stock analysts, hedge fund managers, and other sophisticated institutional investors, you might decide to hold the stock with the expectation it will increase in value. You may, in fact, have a better sense of your company’s competitive position than outside analysts because you work in the company and are particularly attuned to its progress.
But beware of “familiarity bias,” an investment bias known in the field of behavioral economics. This bias occurs when investors prefer familiar or well-known investments, such as stock in the company they work for, instead of a safer and better-diversified portfolio. Be sure to differentiate true insights based on concrete analysis from “having a feeling the stock will go up,” which is probably a result of familiarity bias.
Then weigh your options, and make an informed decision about whether to sell or keep your RSU shares.