What is a ‘Restricted Stock Unit – RSU’
A restricted stock unit (RSU) is a compensation issued by an employer to an employee in the form of company stock. Restricted stock units are issued to an employee through a vesting plan and distribution schedule after achieving required performance milestones or upon remaining with their employer for a particular length of time. RSUs give an employee interest in company stock but have no tangible value until vesting is complete. The restricted stock units are assigned a fair market value when they vest. Upon vesting, they are considered income, and a portion of the shares is withheld to pay income taxes. The employee receives the remaining shares and can sell them at his or her discretion.
BREAKING DOWN ‘Restricted Stock Unit – RSU’
Suppose Madeline receives a job offer. Because the company thinks Madeline’s skill set is valuable and hopes she remains a long-term employee, it offers her 1,000 RSUs as part of her compensation, in addition to a salary and benefits. The company’s stock is worth $10 per share, making the RSUs potentially worth an additional $10,000. To give Madeline an incentive to stay with the company and receive the 1,000 shares, it puts the RSUs on a five-year vesting schedule. After one year of employment, Madeline receives 200 shares; after two years, she receives another 200 and so on until she acquires all 1,000 shares at the end of the vesting period. Depending on how the company’s stock performs, Madeline may receive more or less than $10,000.
Advantages of Restricted Stock Units
RSUs give an employee an incentive to stay with a company long term and help it perform well so that their shares increase in value. If an employee decides to hold their shares until they receive the full vested allocation, and the company’s stock rises, they receive the capital gain, minus the value of the shares withheld for income taxes and the amount due in capital gains taxes. Administration costs are minimal for employers as there aren’t actual shares to track and record. RSUs also allow a company to defer issuing shares until the vesting schedule is complete, which helps delay the dilution of its shares.
Limitations of Restricted Stock Units
RSUs don’t provide dividends as actual shares are not allocated, however, an employer may pay dividend equivalents that can be moved into an escrow account to help offset withholding taxes, or reinvested through the purchase of additional shares. RSUs aren’t eligible for the Internal Revenue Code (IRC) 83(b) Election, which allows an employee to pay tax before vesting, as the Internal Revenue Service (IRS) doesn’t consider them tangible property. RSUs don’t have voting rights until actual shares get issued to an employee at vesting. If an employee leaves before the conclusion of their vesting schedule, they forfeit the remaining shares to the company. For instance, If John’s vesting schedule consists of 5,000 RSUs over two years and he resigns after 12 months, he forfeits 2,500 RSUs.