What Are Restricted Stock Units?

One way company managers can reward employees with a stake in the business is through restricted stock units. RSUs have become a popular means of awarding equity to employees; tech startups as well as larger and more established public companies grant their employees RSUs.

While many people may be familiar with the idea of stock options--where companies give employees the ability to buy stock at a specific, usually discounted price--RSUs work a bit differently. Read on to learn more about this type of stock-based compensation.

What Are Restricted Stock Units? Essentially, RSUs are a company's promise to give you shares of the company's stock on a future date if certain conditions are met. As a result, they hold no actual value at the time they are granted.

Once the shares have vested--meaning you’ve met the requirements to receive the shares and they’re in your possession--the value is whatever the stock is worth. It doesn't matter what the stock price was on the grant date, or any other date--the only price that matters is the price on the date of delivery. After they are delivered, the shares are generally no different than any other stock that you might own. (Although your company may have restrictions on when you can buy or sell shares while an employee, known as a "blackout period").

For instance, let's say your company grants you 200 RSUs. When the shares are granted to you, the company's stock price was $100 per share. The potential future value of the grant is $20,000 (200 x $100). If the stock price rises to $120 by the time the shares are vested and delivered to you, the actual value of the grant is $24,000.

How Are RSUs 'Restricted'? In order to receive your RSUs, certain conditions must be satisfied. Most importantly, the grant is "restricted" because it is subject to a vesting schedule, which can be:

1. Time-based (that is, you must be employed with the company for a specific amount of time);
2. Performance-based (that is, your company meets certain milestones, gets acquired, or goes public);
3. A combination of the two.

When these restrictions are satisfied, which are outlined in your RSU grant, your RSUs will vest, and the shares will belong to you outright.

How Are RSUs Taxed? While RSUs come at no upfront cost to you, it's critical to understand their tax implications.

When RSUs vest, that vested amount is considered (for tax purposes) income, similar to your regular pay. As a result, you will generally owe taxes on the market value of the shares when they were delivered. That includes federal income tax, Social Security, Medicare, and any state and local tax.

Depending on your company’s approach, your RSUs may also be subject to mandatory supplemental wage withholding. Your employer may allow you to choose among different tax-withholding methods, including different ways to pay the taxes due at vesting. The most common practice is to surrender some of the vested shares to cover the associated taxes. For instance, if 100 shares have vested, you might receive 70 shares, surrendering 30 shares to pay the taxes associated with vesting.

Keep in mind that the amount of tax withheld is often the mandatory withholding requirement, but it may not be enough to cover your actual tax bill. Knowing whether you’ve generated enough cash to cover your tax liability when your RSUs vest is one of the many reasons to be proactive with financial planning.

Financial Planning With RSUs If you own RSUs, you should ask yourself what you want to do with the shares after they vest. Will you hold them or sell them? One thing to consider is how much of your own financial success you are willing to tie to the success of your employer. A risk with having a lot of investable assets tied up in your company stock is that if the company were to hit hard times, you could lose your job and your company stock could plummet in value.

The purpose of investing is to achieve your financial goals, so your answer should align what what you are trying to achieve. Whether you hold your shares or sell them when they vest, being prepared will help you be proactive rather than reactive and make the most of the opportunity RSU grants provide.

Samuel Deane is a financial advisor and CEO of Deane Wealth Management, an independent investment advisory firm for millennials in technology. Samuel specializes in comprehensive financial planning, equity compensation, and tax planning. The views expressed in this article do not necessarily reflect the views of Morningstar.