Takeaways
- Restricted Stock Units (RSUs) are earned shares distributed to employees.
- RSUs have vesting periods that distribute shares over months or years.
- RSUs can make up over half of employee’s overall compensation package.
- RSUs are taxed as ordinary income based on the vesting amount each year.
- RSUs have an immediate value to you once vested and are considered income.
What Are Restricted Stock Units (RSUs)?
Restricted Stock Units (RSU) are a form of equity compensation companies offer employees. Instead of giving cash or immediate shares of stock, an RSU represents a promise to grant company shares in the future, subject to specific employment conditions.
RSUs attract and retain top employee talent, especially in industries like tech or startups. They give employees a direct sense of ownership in the company while incentivizing them to stay and contribute to its long-term growth.
However, RSUs are not actual shares until they are vested and distributed. Until then, they hold no real value and cannot be sold or traded.
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How RSUs Work
Restricted Stock Units are granted to employees as a promise to receive company shares in the future, subject to certain conditions. These conditions are typically outlined in a vesting schedule, determining when the employee earns the right to the shares.
Vesting schedules can vary, but they often follow a time-based format, where shares are awarded incrementally over a set period—such as 25% per year over four years. In some cases, vesting may also depend on achieving specific performance goals, known as performance-based vesting.
Once the shares are vested, RSUs are considered taxable income, and the total value of the shares is based on the company’s stock price at the time of vesting. Employees may hold the shares for future growth or sell them immediately to meet personal finance goals or tax needs.
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Pros of RSUs
RSUs offer several advantages for employees and companies. Here are a couple of the key benefits of RSUs:
- Simplicity: Unlike stock options, RSUs do not require employees to pay a purchase price for the shares. Once vested, employees receive the shares outright.
- Guaranteed Value: Once vested, RSUs hold immediate inherent value because you now hold actual company shares. Even if the stock price drops, RSUs still have worth (unlike stock options, which can become worthless if the stock price falls below the exercise price).
- Employee Retention: RSUs incentivize employees to stay with the company until their shares vest, creating a win-win situation for both parties. Employees can think of RSUs as a cash bonus (in equity form) at each vesting period, which may increase in value over time.
- Alignment With Company Goals: Employees with RSUs are motivated to contribute to the company’s long-term growth since the value of their shares increases as the stock price rises.
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Cons of RSUs
While RSUs have many benefits, they also come with some harry downsides. As an employee, you need to be aware of these disadvantages:
- Tax Implications: RSUs are taxed as ordinary income when they vest, meaning employees must pay taxes even if they have not sold the shares.[1] This can create a financial burden. Most companies allow employees to pay cash for their taxes or withhold a certain number of shares to meet their tax obligation.
- Illiquidity: Employees cannot sell or trade RSUs until they vest, which means you have no control over the timing of your compensation or future tax liability.
- Risk of Stock Price Decline: While RSUs retain value even if the stock price drops, their worth diminishes with a declining share price. Depending on your risk tolerance, it might be worth selling your RSUs as soon as they vest.
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Example of RSUs
Say you worked at a tech company that awarded you 1,000 RSUs as part of your compensation package. The vesting schedule has a four-year cliff, with 25% of the shares vesting annually.
Here is what happens:
- In Year 1, 250 RSUs vest. If the company’s stock price is $50 per share at the time, you receive shares worth $12,500. This amount is taxed as ordinary income.
- In Year 2, another 250 RSUs vest. If the stock price rises to $60, you receive shares worth $15,000, taxed as income.
- In Year 3, another 250 RSUs vest. The stock price has dropped to $45 per share, and you receive shares worth $11,250.
- By Year 4, another 250 RSUs vest. The stock price has returned to $50 per share, and you receive shares worth $12,500.
You have received shares with a market value of $51,250. While you have not paid any money out of your pocket for these shares, you have paid taxes on the vested amount of $51,250.
Now that the shares are fully vested, you can decide to hold or sell them in your online brokerage account.
RSUs vs. Stock Options
Both RSUs and stock options are forms of equity compensation, but they work differently. Here is a quick look at the differences:
| Feature | RSUs | Stock Options |
|---|---|---|
| Cost to Employee | No cost to receive shares | Must pay an exercise price to buy shares |
| Guaranteed Value | Always have some value (if vested) | Can become worthless if stock price drops below exercise price |
| Taxes | Taxed as ordinary income upon vesting (and potentially capital gains when sold) |
Not taxed on exercise of ISOs but taxed when exercising NSOs (and potentially capital gains when sold) |
| Dividends | Not earned pre-vesting | Not earned until shares are purchased |
Source: IRS Website[2]
RSUs are more straightforward and less risky than stock options, making them appealing to many employees. However, stock options can offer higher potential rewards if the stock price appreciates significantly.
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- What Is an Incentive Stock Option (ISO)?
- What Is a Non-Qualified Stock Option (NSO)?
- What Is an Employee Stock Purchase Plan (ESPP)?
Smart Summary
Restricted Stock Units are part of your equity compensation package. RSUs are shares distributed to you based on a vesting schedule and are used by companies to align employee and company interests. They offer employees an easy-to-use form of equity compensation, guaranteed value, and long-term incentives. However, they also come with tax considerations to navigate. Read more in our Equity Compensation Guide.
(1) Internal Revenue Service. Equity (Stock) – Based Compensation Audit Technique Guide. Last Accessed January 11, 2025.
(2) Internal Revenue Service. Topic no. 427, Stock options. Last Accessed January 11, 2025.
