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  • Writer's pictureJiayi (Kristy) Xu, MBA, CFP®

The 5 W’s about diversifying your RSUs

Updated: Jul 22, 2022

Many of my clients are tech employees who have been rewarded with Restricted Stock Units (RSUs) as a part of their total compensation. They devote time and passion toward their work, deeply understand their product and technology, and believe their company will have a bright future. In this blog post I will discuss why you should consider diversifying your RSUs, what basic information you need to know about RSU’s, where you can find more specific information about your grants, who should consider selling RSUs after they vest to diversify, and when you should sell to diversify your portfolio.

Why should you consider diversifying?

Clients are often emotionally attached to their employer’s stock because they have directly contributed to the growth of the company. However, your investments in your company’s stock are much riskier for you as an employee than holding stock issued by other companies. Working and investing in the same company amplifies both industry risks and company specific risks. A challenging time in the industry or a financial obstacle of your company can put your job at risk right when your company’s stock is falling. You risk losing your salary while your stock holdings are less valuable, which would create financial difficulties with maintaining your lifestyle.

What are the basics you need to know?

RSUs are currently one of the most commonly granted types of equity award. Unlike common stock, RSUs usually do not pay dividends and do not confer voting rights. The ownership of shares only occurs at vesting. So before vesting the RSUs are just an unfunded bookkeeping entry rather than actually issued shares. Vesting can occur in increments over the course of the vesting period (graded vesting), or all the shares can be delivered at once on a single vesting date (cliff vesting). Note that an RSU should not be confused with restricted stock, because no company stock is issued at the time of a Restricted Stock Unit grant, no special tax 83(b) elections can be made at grant.

When you receive a grant of RSUs the company will provide you with the grant price, which is the current valuation of those shares. There are no taxes associated with this grant.

When your RSUs vest you will be taxed on the share’s value as of the vesting date. The price of the stock will always vary over time, so the value when your shares vest could be more or less than the original grant price. Your company will withhold estimated federal and state taxes in the same way they withhold portions of your regular salary. You can find your income and this withholding on your paystub or W-2. Most companies will allow you to choose how to pay the tax owed on your vested shares. You can either have your company withhold shares of your newly acquired stock to pay it or pay cash from your own pocket.

The vesting price is your cost basis for the stock. When you sell your shares, you will incur a taxable capital gain if the price of the stock is greater than your cost basis. If you sell at a price lower than your vesting price you will incur a capital loss that you can deduct against capital gains elsewhere in your portfolio.

Where to look for more information?

If you are not sure what type of stock compensation you have been awarded, these are some places to look for details.

You will have received a document that could have been called a grant letter, grant notice, or award letter. This document is specific to you and details your award. It will include the grant date, the number of shares, and the vesting schedule as well as other vesting requirements. Not all vesting schedules are the same, in fact different grants from the same employer may have different vesting schedules.

Your employer has an RSU award agreement that details how their plan is structured, the tax withholding options, and any other provisions of the RSUs.

Once vested, your shares will be held in an account under your name at a financial institution selected by your employer. The login information for this account was provided to you when you were granted the RSUs. Don’t forget to log in and accept your grants!

Who should consider selling for diversification?

The simple answer is everyone should consider selling shares after their RSUs vest to diversify their portfolio. However, some people must consider diversifying more urgently than others.

In the early years of your career the value of your company stock is likely not a significant fraction of your wealth. At this stage in life, you can have a well-diversified portfolio without selling your vested stock so long as you have other investments. Holding onto your vested stock will not overly skew the composition of your wealth or risk your overall financial well-being.

Over time as you advance and thrive in your company you will likely be granted more and more shares. There are two traps that you need to avoid at this stage. If the price continues to rise, you will soon find that a large portion of your net worth is held in your employer’s stock. A financial planning rule of thumb is to not let a single stock holding make up more than 5% of your investment portfolio. Yet people often become emotionally attached to their investment holdings and the longer you hold them, the more difficult it is for you to make the decision to sell. Once you have fallen into this trap, it is increasingly more difficult to achieve diversification than if you had planned to gradually sell and diversify early.

While the first trap is difficult to climb out of, the second trap is far worse. If the stock price falls after your shares have vested, you still owe taxes on the vesting price of your shares. Usually, your employer will have withheld a flat rate of 22% according to the IRS supplemental wage income rule, and this rate is typically lower than your marginal income tax rate. You must then pay the difference between 22% and your marginal tax rate. Many people choose to cover this difference by selling vested shares. However, if you wait too long to do this, and the value of your vested shares has dropped significantly, in a worst-case scenario you will owe more in taxes than your remaining vested shares are worth.

Even in a non-worst-case scenario, you may have to sell many more of your vested shares than you would have if you had planned ahead.

If you think that could not happen to your employer’s stock, I assure you that tech employees in the 90’s thought the same just before the dotcom bubble burst. (Many of our clients who were born in the 90’s won’t remember how tech employees who exercised their non-qualified stock options as the stock was skyrocketing incurred a massive tax bill upon exercise. Thinking that the stock prices would continue to rise, many held onto all of their shares rather than selling some to cover their tax bills. Unfortunately, when the bubble burst and stock prices plummeted, some found that their total holdings were worth less than what they owed in taxes.)

When would be a good time to sell?

When exactly you should diversify your portfolio by selling some of your vested shares depends on your specific financial situation, but I recommend my clients follow a sell schedule that we plan together. Similar to how I use dollar cost averaging when buying into the market, a sell schedule is an intentional and systematic process to diversify your portfolio away from a concentration of your employer’s stock in a way that allows you to rationally participate in the upside and manage the downside. A preset sell schedule keeps your position in your employer’s stock from riskily dominating your portfolio, and helps you avoid falling into either of the above two traps. To develop your sell schedule and diversification strategy you should not only consider the terms of your award agreement and the tax implications of your employer stocks, but also your overall financial picture and your financial goals.

I would love to help you better understand your stock compensation and come up with strategies that are in accordance with your financial goals.

If you would like to discuss your question about your RSUs with me but are new to my firm, let’s set up a free introductory call!

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