How Restricted Stock Units (RSUs) Work
What is an RSU?
A Restricted Stock Unit (RSU) is a form of equity compensation granted to employees by their employer. RSUs serve as a long-term incentive to retain employees and align their interests with the company's performance. Unlike stock options, RSUs represent a promise to deliver company shares in the future, typically after a vesting period.
When an employer grants RSUs, the employee does not immediately receive the stock. Instead, the shares are subject to vesting conditions, meaning the employee must fulfill certain requirements (such as continued employment) before gaining ownership.
Example of RSU Grant and Vesting
Let's say an employee receives 1,000 RSUs as part of their compensation package. The employer sets a four-year vesting schedule, meaning the RSUs will vest gradually over four years. A common vesting structure is:
| Year | Shares Vested |
|---|---|
| 1st Anniversary | 250 shares (25%) |
| 2nd Anniversary | 250 shares (25%) |
| 3rd Anniversary | 250 shares (25%) |
| 4th Anniversary | 250 shares (25%) |
If the company's stock price is $50 per share at the time of the grant, the total potential value of the RSUs is:
1,000 RSUs × $50 = $50,000
However, because the shares are restricted, the employee cannot sell or transfer them until they vest. Once vested, the employee can either hold onto the shares for potential future gains or sell them to realize their value.
How RSUs Are Taxed
RSUs are taxed as ordinary income when they vest. The taxable amount is calculated as:
Number of vested shares × stock price at vesting
For example, if 250 shares vest and the stock price is now $60 per share, the taxable income would be:
250 × $60 = $15,000
The employer typically withholds a portion of the shares or cash to cover federal and state taxes.
Risks and Considerations
✅ Potential for Growth
If the company's stock price increases over time, RSUs can become significantly more valuable.
❌ Downside Risk
If the stock price declines, the RSUs may be worth less than their original grant value.
🏦 Liquidity Considerations
Since RSUs are taxed upon vesting, employees may need to sell shares to cover tax liabilities.
Final Thoughts
RSUs can be a valuable part of an employee's compensation package, providing a direct stake in the company's success. However, understanding vesting schedules, taxation, and market risks is crucial for making informed financial decisions.
For more insights on equity compensation, explore our RSU tax calculator.