Understanding How Restricted Stock Units Work

Restricted Stock Units (RSUs) are becoming an increasingly popular form of compensation, especially in startups and large public companies. While they offer employees a stake in the company's success, understanding how they work—and the potential financial and tax implications—can be complicated. 

Many employees are granted RSUs as part of their compensation packages, expecting to benefit from their company's success. However, when the RSUs finally vest, employees are often surprised by a sizable tax bill and the fluctuating value of their shares. 

This situation can lead to financial uncertainty, especially if employees haven’t fully grasped the implications of their equity compensation.

In this article, we will break down everything you need to know about RSUs—what they are, how they work, and what you need to consider when managing them in your financial strategy. Whether you are new to RSUs or looking to gain a clearer understanding, this guide will help you tackle RSUs with confidence and clarity.
 

What Are Restricted Stock Units (RSUs)?

Restricted Stock Units (RSUs) are a form of equity compensation offered by companies to their employees. Unlike stock options, which give employees the right to purchase shares at a set price, RSUs represent actual company stock granted to employees, typically over time or upon achieving certain performance goals. 

However, these units are "restricted" in nature and cannot be fully owned or sold until they vest. This means employees must meet specific conditions, such as staying with the company for a certain number of years or meeting performance targets.

RSUs serve as an attractive tool for companies to retain talent and align employees’ interests with company success. As the company grows and its stock price increases, employees stand to benefit, directly linking their compensation to the company’s performance. This can serve as a strong incentive for employees to contribute to the company's long-term success.

One key difference between RSUs and other equity compensation methods, like stock options, is that RSUs have no purchase price for employees. They are simply granted and eventually converted into shares of stock. 

However, this also means that RSUs are typically taxed at the time they vest, unlike stock options, which are only taxed when the shares are sold.

Suggested Read: Understanding the Importance of Compensation Management
 

How Do RSUs Work?

RSUs are granted to employees as part of their compensation package, but the shares aren’t immediately given to the employee. Instead, they "vest" over a period of time, which means the employee must meet certain conditions before they can fully own and sell the shares. 

Understanding how RSUs work is crucial, as the vesting schedule, tax implications, and potential risks can affect your financial planning.

Vesting Schedule

The vesting schedule determines when the employee can take full ownership of the RSUs. There are typically two types of vesting schedules:

• Time-Based Vesting: The most common form of RSU vesting. Employees receive their RSUs over a set period of time, typically four years. For example, a company might grant 1,000 RSUs with a four-year vesting schedule, where 25% vests each year. This method encourages employees to stay with the company long-term.
• Performance-Based Vesting: In this case, RSUs vest based on meeting certain performance criteria, such as achieving specific revenue targets or individual performance goals. If the employee meets the set targets, they are granted their shares.
   

Post-Vesting

Once the RSUs vest, the employee owns the shares outright and can sell them or keep them. However, the process of vesting triggers a taxable event, meaning the value of the shares at the time of vesting is treated as ordinary income for tax purposes.

For example, if an employee’s 500 RSUs vest when the stock price is $50 per share, they would owe taxes on $25,000 (500 shares x $50) as income. If the employee sells the shares after they vest, any additional gain (or loss) will be taxed as a capital gain (short-term or long-term, depending on how long they hold the shares).

In some cases, companies may withhold a portion of the vested shares to cover the tax liability, particularly for employees in higher tax brackets.

Example: RSUs in Action

Let’s look at a simple example to illustrate how RSUs work in practice:

• An employee is granted 1,000 RSUs with a four-year vesting schedule (250 shares per year).
• After the first year, 250 shares vest. At the time of vesting, the stock price is $60 per share.
• The employee owes taxes on $15,000 (250 shares x $60), and the company may withhold a portion to cover this tax.
• If the employee holds onto the shares, and the stock price increases to $70 per share by the time the second year’s RSUs vest, they benefit from that increase in value when they sell the shares. However, they will still pay taxes on the value of the shares at the time of vesting, not the later selling price.

This illustrates how RSUs allow employees to benefit from their company’s growth. At the same time, they are tied to both the company’s performance and the tax implications that arise when the RSUs vest.

Suggested Read: How to Build Pay Structures: Pros and Cons of Salary Bands and Pay Ranges

Now that we have covered the basics of how RSUs work and the process involved, it’s important to dive deeper into the different types of vesting schedules. 
 

Types of Vesting Schedules for RSUs

The vesting schedule plays a critical role in how and when employees gain access to their RSUs. It determines the timeline for employees to earn the rights to their shares, and it can be structured in different ways. 

Companies typically use time-based, performance-based, or hybrid vesting schedules to align employee interests with long-term company goals. Understanding the different types of vesting schedules will help employees plan for when they can expect to fully benefit from their RSUs.

Time-Based Vesting

Time-based vesting is the most common type of RSU vesting. In this arrangement, the RSUs vest over a predetermined period, often with a cliff (initial waiting period) and then incremental vesting on a regular basis. This method encourages employees to stay with the company for a longer period.

These are of two major types:

Cliff Vesting

With cliff vesting, the employee must stay with the company for a set period before any shares vest. For example, a company may have a three-year cliff vesting schedule. This means that the employee won’t receive any shares until the end of the third year, at which point a large portion of their RSUs (typically 100%) vests. After the cliff, subsequent shares might vest annually, quarterly, or monthly.

Gradual Vesting

After the cliff period (or if there’s no cliff), the RSUs typically vest gradually, either annually or quarterly. A common structure is 25% of the RSUs vesting each year over four years. This ensures that the employee is incentivized to remain with the company long-term.

Both cliff vesting and gradual vesting aim to incentivize long-term retention and align employee interests with the company’s growth. 

Pros: Simple and predictable. Employees know when their RSUs will vest, providing clear financial planning.

Cons: Employees might feel disengaged if the vesting period is long or if the cliff is too far in the future.

Performance-Based Vesting

Performance-based vesting ties the vesting of RSUs to the achievement of certain company or individual performance goals. 

These goals could be based on specific financial targets (such as revenue or earnings growth), personal milestones (like completing a significant project), or a combination of both.

• Company Performance: In some cases, the RSUs only vest if the company meets certain targets, such as reaching a specific stock price or achieving a certain level of profitability.
• Individual Performance: RSUs may vest based on an employee’s performance metrics. For example, an employee might be granted RSUs that will vest if they hit specific sales goals or complete a high-level project within a certain timeframe.

Performance-based vesting can be more complex than time-based vesting, but it can also provide stronger incentives for employees to perform at their highest level. 

Employees who meet their performance goals can realize significant rewards, but they must take an active role in driving success.

Pros: Aligns employee interests with company success, as employees are directly rewarded for their performance.

Cons: Can be challenging to meet performance targets, especially in volatile or unpredictable industries.

Hybrid Vesting

A hybrid vesting schedule combines both time-based and performance-based conditions for RSU vesting. This type of vesting provides a balance between rewarding long-term commitment and incentivizing performance. 

For instance, a company might structure vesting so that 50% of the RSUs vest over time (e.g., 25% per year for four years), and the other 50% vest based on the achievement of performance goals.

• Example: An employee may have 1,000 RSUs, with 500 vesting over four years, and the remaining 500 vesting only if the company meets certain performance goals, such as achieving revenue growth targets.

Hybrid vesting schedules can be highly motivating for employees because they offer both the stability of time-based rewards and the excitement of achieving performance-based goals.

Pros: Offers a balance between rewarding longevity and incentivizing performance.

Cons: Can be more complex to manage and track, with both time and performance metrics involved.

Suggested Read: How to Determine and Build a Compensation Range?

Employees can set realistic expectations and prepare for when they can expect to fully benefit from their RSUs by learning more about vesting schedules. It’s essential to factor these schedules into personal financial planning and to be aware of any potential tax implications tied to the vesting process.

After understanding how RSUs work and the different types of vesting schedules, it’s important to explore the advantages they offer. RSUs provide several benefits to employees that can make them a compelling form of compensation.
 

Key Benefits of RSUs

Restricted Stock Units (RSUs) offer a variety of benefits to both employees and companies. For employees, RSUs can be a valuable form of compensation that aligns their interests with the company's success.

On the other hand, companies use RSUs to attract, retain, and motivate top talent. Understanding the advantages of RSUs helps employees make informed decisions about how to maximize the potential of their equity compensation.

Let’s explore the key benefits of RSUs in more detail.

• Company Success: RSUs give employees a vested interest in the company’s growth, as the value of their shares increases with the company’s performance. This encourages employees to focus on the long-term success of the company.
• Predictability: Unlike stock options, which may have a complex strike price and expiration date, RSUs are simpler to understand. Employees receive actual shares, and the vesting schedule is clear, making it easier to plan financially.
• No Upfront Cost: With RSUs, employees don’t need to purchase shares. They are granted shares that will vest over time, eliminating the need for employees to pay any initial cost or risk associated with buying stock options.
• Tax Treatment: In some cases, RSUs offer favorable tax treatment compared to other types of equity compensation. Taxes are typically due at the time of vesting, which means employees can plan for their tax liability.

Understanding these benefits helps employees navigate the RSU process effectively, making the most of the rewards tied to their company’s performance while minimizing the associated risks.

While RSUs offer several key benefits, there are also some potential drawbacks to consider. Employees need to weigh these challenges against the advantages in order to make well-informed decisions about their equity compensation.
 

Potential Drawbacks of RSUs

Despite the many advantages of RSUs, there are several potential drawbacks that employees should consider when evaluating this form of compensation. Understanding these downsides can help you make more informed decisions and avoid surprises when your RSUs vest. 

Here are some of the key challenges associated with RSUs:

• No Immediate Ownership: RSUs do not provide ownership until they vest. This means employees may need to wait several years before fully benefiting from their equity compensation.
• Stock Price Volatility: The value of RSUs is directly tied to the performance of the company’s stock. This volatility can make RSUs a less predictable form of compensation, and employees may find that their shares are worth less than expected at the time of vesting.
• Large Tax Bills: When RSUs vest, the value of the shares is considered taxable income. In some cases, employees may find themselves with a large tax bill that they weren’t prepared for.
• Impact of Exiting: If an employee leaves the company before their RSUs vest, they may forfeit any unvested shares. Leaving the company voluntarily or for other reasons typically results in the loss of unvested RSUs.

While these drawbacks may seem significant, they can often be mitigated with proper planning and understanding of how RSUs work. Employees need to consider these potential risks and be prepared to manage their RSUs effectively in order to maximize their value.

Having explored the benefits and drawbacks of RSUs, it’s important to understand how they are taxed. The tax treatment of RSUs can be complex, and knowing when and how taxes are applied will help you handle the process more effectively.
 

Tax Implications of RSUs

When it comes to RSUs, understanding the tax implications is critical for managing your compensation effectively. Unlike stock options, which are only taxed when shares are sold, RSUs are taxed at the time of vesting. 

Here’s a breakdown of the key tax considerations:

Taxation at Vesting

• RSUs are considered ordinary income when they vest.
• The fair market value of the shares at vesting is taxed as income at your regular tax rate.
• This means if the stock price has increased significantly from the grant date to the vesting date, the tax burden can be substantial.
   

Withholding Taxes

• When RSUs vest, your employer withholds taxes based on the value of the shares at the time of vesting, much like how income taxes are withheld from your paycheck.
• The company may withhold a portion of the shares to cover these taxes, reducing the number of shares you actually receive.
   

Capital Gains Tax 

• Once RSUs vest and you own the shares, capital gains taxes apply when you sell the shares.
• If you sell the shares within a year of vesting, the gain is considered short-term capital gains, taxed at your ordinary income rate.
• If you hold the shares for more than a year, any gains are considered long-term capital gains, which are typically taxed at a lower rate.
   

Potential for Double Taxation

• Employees may feel that RSUs are subject to double taxation: first, as ordinary income when the RSUs vest, and second, as capital gains when the shares are sold.
• While this is a standard taxation method for most equity compensation, it’s important to understand and plan for this dual tax event.
   

Tax Planning Strategies

• Some employees sell a portion of their RSUs immediately upon vesting to cover the taxes owed.
• Alternatively, employees can choose to hold the shares in the hopes of future growth, but this could create additional tax implications depending on stock price changes.
• Consulting a tax professional is highly recommended to develop a strategy that minimizes the overall tax burden.

Understanding the tax implications of RSUs is essential for managing your equity compensation effectively. By planning and considering tax strategies, you can avoid unpleasant surprises and ensure that your RSUs provide the financial benefits you expect.

Now that we have covered the tax implications of RSUs, it’s important to understand how to make them a part of the compensation strategy. 
 

Plan for RSUs in Financial Strategy

RSUs not only serve as a retention tool but also as a way to motivate employees to align their performance with company goals. However, without proper planning, both employees and the company could face unexpected financial challenges when these units vest. 

Here’s how you can help employees plan for their RSUs, while also integrating them into the broader financial strategy of your organization.

• Educate Employees: Provide resources or training to help employees understand RSUs, including vesting schedules and tax implications.
• Offer Tax Guidance: Partner with financial advisors to assist employees in managing the tax burden when RSUs vest.
• Encourage Diversification: Advise employees to diversify their investments and avoid over-concentration in company stock.
• Support Retirement Planning: Help employees incorporate RSUs into long-term financial goals, such as contributing to retirement accounts.
• Align RSUs with Company Goals: Ensure RSUs drive performance and retention by aligning them with business objectives.
• Review Plans Regularly: Periodically evaluate RSU structures to ensure they meet evolving company goals and remain competitive.

HR managers can help employees make informed decisions by following these steps. This will lead to better financial outcomes and stronger retention. 

Suggested Read: Defining DEIB: Understanding Diversity, Equity, Inclusion, and Belonging at Work

To streamline the management of RSUs, tools like CompUp can provide valuable support. Let’s explore how CompUp can help optimize RSU tracking and enhance the overall efficiency of your compensation programs.
 

CompUp Can Help Manage RSUs Effectively

As RSUs become an increasingly popular form of compensation, HR managers need to have the right tools in place to manage this equity-based reward. CompUp provides a comprehensive platform that simplifies the management of RSUs and other forms of employee compensation. 

HR teams can achieve transparency, compliance, and efficiency in managing RSU plans by utilizing CompUp's data-driven insights and automated processes. These are a few ways in which CompUp can help. 

RSU Tracking 

CompUp makes it easy to track the vesting schedules of RSUs, providing real-time data on when shares are set to vest and the value of those shares. With automated reporting, HR managers can ensure they have up-to-date information at their fingertips. This can reduce the risk of errors and ensure employees receive accurate information regarding their RSUs.

Tax Reporting

One of the key challenges with RSUs is managing the tax implications when shares vest. CompUp helps HR managers handle this complexity by automatically calculating the tax liabilities associated with RSU vesting. 

The platform provides detailed reports that can assist with tax compliance. This makes it easier to handle withholding taxes and ensure that both the company and employees meet their tax obligations.

Customizable Schedules

Every company’s RSU program is unique, and CompUp offers the flexibility to design customizable vesting schedules that meet your organization’s needs. Whether you use time-based, performance-based, or hybrid vesting models, CompUp can handle them all. The platform allows you to personalize the RSU plan to better align with your company’s goals and employee retention strategy.

Employee Engagement

Effective communication is key to managing RSUs, and CompUp helps facilitate this by providing employees with easy access to information about their RSU balances, vesting schedules, and tax implications. With CompUp’s employee dashboard, employees can track their progress and gain a clearer understanding of how their RSUs are impacting their compensation and long-term financial strategy.

Integration with HR Systems

CompUp integrates seamlessly with existing HR and payroll systems, ensuring that RSUs are properly accounted for in broader compensation management workflows. By consolidating equity compensation data in one platform, HR managers can easily track all aspects of employee compensation, including salary, bonuses, and RSUs, ensuring consistency and accuracy across the board.

Data-Driven Insights 

CompUp offers powerful analytics tools that provide HR teams with insights into the effectiveness of their RSU plans. By analyzing trends such as employee retention rates, vesting timelines, and RSU performance, HR managers can gain valuable insights into the effectiveness of their equity compensation strategies. This data allows them to make informed decisions on how to optimize these strategies and better align them with company objectives.

HR managers can simplify the complex process of managing RSUs by using CompUp. With its comprehensive features, CompUp empowers HR teams to manage RSU programs more efficiently and effectively. The platform can help you maximize the impact of equity compensation within your organization.
 

Conclusion

Restricted Stock Units (RSUs) can be a powerful tool by aligning employees' interests with the success of the company. However, understanding how RSUs work—along with their tax implications, vesting schedules, and potential drawbacks—is necessary for employees and HR managers alike. 

Platforms like CompUp can simplify the management of RSUs by automating processes, ensuring compliance, and providing real-time insights into vesting schedules and performance. This not only reduces administrative burden but also empowers HR teams to make data-driven decisions that optimize the value of equity compensation programs. 

Explore how CompUp can turn data into actionable insights that align your RSU program with your business objectives. Start your free trial today.
 

Frequently Asked Questions

How are RSUs different from stock options?

Unlike stock options, which allow employees to purchase shares at a set price, RSUs are granted as actual shares of stock that vest over time. RSUs do not require employees to purchase the stock and are taxed as ordinary income at the time of vesting.

Can CompUp automate RSU tax calculations?

Yes, CompUp automates the calculation of tax liabilities at the time of RSU vesting. It ensures that the appropriate amount of tax is withheld and provides reports to help HR teams manage compliance and financial planning.

How does CompUp track RSU vesting schedules?

CompUp tracks RSU vesting schedules automatically, sending reminders and updates to HR teams and employees. The platform provides a clear overview of when shares will vest and the associated financial impacts, ensuring no key dates are missed.

Does CompUp provide reporting for RSU performance?

Absolutely. CompUp offers comprehensive reporting features that track RSU performance, vesting timelines, and employee participation. These reports give HR managers valuable insights to optimize compensation strategies and assess the effectiveness of RSU programs.