Common Mistakes in Managing RSUs
In our experience, most recipients of Restricted Stock Units (RSUs) make managing their company stock overly complicated. This typically happens for one of three reasons:
- Recipients incorrectly think they can reduce or avoid taxes by holding restricted shares for at least a year after vesting. As we explained in our post about how restricted shares are taxed ("How Are My Restricted Stock Units Taxed?"), this is not true.
- They are optimistic about their employer's long-term prospects and want to hold the stock for investment reasons. If the employer's stock performs well, this can obviously work out in the recipient's favor. However, it also increases the portfolio's risk and makes the employee's financial plan heavily dependent on the performance of one stock. As proponents of diversification, we always recommend against this.
- Inertia! Many recipients of restricted stock do not proactively manage the tax and investment implications of their employer stock, passively letting their shares build up over several years.
When a recipient fails to proactively manage their restricted shares, it can often result in a complicated financial situation with unwanted (or worse, unexpected) tax implications. Fortunately, the most tax efficient way to manage your RSUs is fairly simple.
A Simple Strategy for RSUs (Almost) Every Recipient Should Follow
So what's the most tax efficient way to manage your restricted stock?
Sell your shares immediately upon vesting.
In nearly all cases, this is most advantageous approach, especially if you expect to receive new awards each year going forward. Following this strategy allows you to kill two birds with one stone: reduce concentration risk in your portfolio and avoid building up large unrealized gains, which would create a large tax impact down the road.
Sometimes, your employer will allow you to elect to automatically have your shares sold immediately at vesting. If your plan does not have this option, then you can simply set a reminder on your calendar when your shares vest so that you can sell them that day.
Why Selling Your Shares Upon Vesting Makes Sense
So why does this make sense for most recipients for restricted stock?
- The ordinary income realized at vesting cannot be avoided. Holding your shares longer does not allow you to avoid, reduce, or convert this to capital gain income. From this standpoint, there is no benefit to holding longer.
- Your capital gain will naturally be zero (or close to zero) if you sell them immediately because your tax basis is equal to their value at the moment they vest.
- Selling immediately allows you to reduce concentration risk more quickly by lowering your exposure to your employer and reinvesting in a diversified portfolio.
A common misconception is that you benefit by holding your shares for at least one year because long-term capital gains (i.e. held for more than one year) are taxed at a lower rate than short-term capital gains (i.e. held for less than one year). However, this becomes irrelevant if you sell immediately upon vesting because (as noted in our second point above) there will be no capital gains if your shares are sold immediately.
Of course, you will need to consider your specific situation before moving forward with this approach. Sometimes (although rarely) there are good reasons to not sell, such as corporate hold requirements or internal politics. These reasons typically have less to do with the tax and investment consequences of employer stock, and more to do with the legal and political ramifications. Let’s be clear about one thing: “the price might go up” is not a good reason to continue to hold your company stock and avoid diversifying.
Check out the above video, where Trailhead Partner, Bill Mulvahill, CFP®, CPA, discusses this strategy and more.