Time for a Refresher: Don’t Leave Restricted Stock on the Table
Imagine receiving an award from your employer for the value that you bring to the table, but the payout doesn’t come for months or even years down the road. If you work in the tech industry, or otherwise receive a stock award from one year to the next, then you’ll likely understand how exciting and at the same time, how bewildering it can be to receive what can be a significant portion of your income doled out over an extended period of time.
That’s why understanding this often complex form of incentive compensation is essential to making wise choices with your income and to avoid leaving money on the table.
Now, when it comes to incentive compensation, restricted stock is one of the most commonly granted forms of income issued to individuals employed by publicly traded tech companies. And, if you’re one of these fortunate individuals, chances are that you’re likely in line for a new stock award or refresh grant as we roll into this year’s performance evaluation and bonus season.
And because these awards can make up a sizable portion of your overall income, it’s essential to understand what you should be aware of when you receive your grant, what happens when your grants vest, and your options for preserving your wealth and income.
Before we dive in on these critical points, let’s take a step back and talk through some definitions regarding restricted stock that you should be familiar with.
What is Restricted Stock?
At its basic level, restricted stock is the ability to own equity in the company you work for without your need to pay for the stock itself. And restricted stock is a form of compensation because when you satisfy the conditions imposed by your company, you often receive the shares free and clear.
When it comes to terminology, you’ll want to understand the difference between restricted stock units and restricted stock awards.
So what are Restricted stock units? Well, a restricted stock unit (or RSU) is a right to receive company shares after you’ve satisfied some conditions imposed by your employer. These criteria might include hitting a certain sales quota, department performance goal, or, what’s most common for many of you out there, is simply continuing to work for your employer for an agreed amount of time. The key takeaway here is that you only own the shares once you’ve met specific criteria defined in your grant. It’s like an unfunded promise by your employer that you’ll receive company stock at some point in the future once you achieve certain milestones.
And so, how are RSUs different from restricted stock awards? Well, a restricted stock award (sometimes called a restricted stock grant) provides essentially the same benefit as an RSU. However, the key difference is that with a restricted stock award, shares are transferred to you at the time of the grant but are subject to forfeiture if you don’t meet specific performance criteria. This could include, for example, leaving your company before your shares vest. What’s more, these shares are typically held in a third-party escrow account and are released to you as conditions for vesting (or ownership) are met.
Now, there’s one more definition of restricted stock out there, and that’s GSUs.
Now, GSU stands for “Google Stock Units,” a form of equity compensation that Google offers its employees. GSUs represent a promise to receive a specified number of shares of Google stock at a future date, typically after a vesting period. A Google employee’s typical GSU vesting schedule is four years, with 25% of the total grant vesting each year. This means that after the first year, an employee would have 25% of their GSUs vested, after the second year, 50% would be vested, and so on until all of the GSUs are vested after four years.
The main difference between Google’s GSU vesting schedule and traditional restricted stock vesting schedules is that Google offers a “graduated vesting” schedule, which means that GSUs vest on a quarterly (and sometimes monthly) basis after the first year of employment. This means that if you stay with Google for at least one year, you would receive the first 25% of the total grant, and then the remaining 75% would vest on a quarterly (or again monthly) basis over the next three years.
It’s worth noting that specific vesting schedules for restricted stock can vary depending on the company and the individual grant. What this means, plain and simple, is that until your stocks vest, you don’t have full ownership of it yet. Indeed, it’s essential to carefully review the terms of any restricted stock grant to understand the specific vesting schedule and other conditions that may apply. Either way, whether you receive a new award or refresh grant this bonus season, be sure to familiarize yourself with the type of restricted stock you received and the vesting schedule so that you can make the most of your equity awards.
Restricted Stock and Taxes
Another topic related to your restricted stock that you’ll likely want to familiarize yourself with is taxes.
To our earlier point, restricted stock is the ability to own equity in the company you work for without your need to pay for the stock. Even so, the tax man will want to get his fair share once you get paid.
Now, when it comes to paying Uncle Sam, the tax consequences of RSUs (and GSUs) are relatively straightforward. For example, when the shares are granted, you typically do not have to pay taxes on them. That’s because, in many cases, there is a substantial risk of forfeiture for not meeting the vesting criteria. Therefore, you’re typically not taxed on the grant itself, but rather when your awards actually vest.
At the point when your restricted stock vests, the value of the shares received is considered income, and you’ll likely pay tax on the vested shares at an ordinary income tax rate. How much you will pay all depends on your individual tax bracket. And the more of your income that comes from restricted stock, the higher you’ll likely move in marginal tax brackets.
When it comes to paying taxes, some employers may offer to withhold a certain percentage of your vested stock to pay what’s due to state and federal authorities. While this approach is helpful, in many cases, withholdings can often be too low, which can lead to a surprise tax bill at the end of the year. That’s why it’s essential to understand your current income and tax situation, especially if you’re a single or a high earner, to understand whether to increase your tax withholdings as shares vest or to prepare to make estimated quarterly tax payments.
One benefit of restricted stock is that you can defer the distribution of shares until a later date. This allows you to benefit from the potential growth in the stock while you’re waiting to receive the shares. Deferring the distribution of shares can also help reduce the amount of taxes you must pay when the shares are distributed, as you could be taxed at a lower rate.
A situation like this may apply if you anticipate your earnings in your retirement years to be substantially lower than in your current working years. Either way, consider whether it would be advantageous to choose a future payment date to coordinate the timing of tax recognition with your overall exercise plan.
What to Do with Vested Stock
So, once your restricted stock vests, what happens next?
Well, when your restricted stock vest, you’ll either receive a cash settlement or stock settlement. That’s why reviewing your equity grant is essential to getting a good handle on how your stock award will be paid out.
If you receive a stock settlement, then for all intents and purposes, that restricted stock is now company stock you own free and clear. Once it’s transferred to a brokerage account, you can hold onto it, sell it, or borrow against the stock. One option many individuals choose is to sell their shares immediately as they vest to lock in gains and avoid future market volatility or unwanted tax liabilities from the appreciation of their company shares.
Now, if you plan to hold onto your stock or trade your recently received shares, you’ll want to be aware of any blackout periods, trading windows, or other limitations on your ability to sell shares. For example, your company may enter blackout periods during earnings season and ask employees not to sell company stock. That’s why it’s essential to review your stock grant and check with your benefits administration team for clarification on blackout periods.
Now, if you want to sell your restricted stock without the hassle of keeping track of blackout periods and trading windows, consider a 10b5-1 plan.
A 10b5-1 plan is a pre-established trading plan that allows insiders, such as corporate officers or employees who hold restricted stock, to sell a predetermined number of shares at predetermined times. The plan is designed to ensure that the sale of shares is conducted in an orderly and transparent manner and that the individual selling the shares is not privileged to any material, nonpublic information at the time of the sale.
The key advantage of a 10b5-1 plan is that it allows insiders to sell shares on a regular basis without raising concerns about insider trading or other ethical issues. The plan is set up in advance and based on a predetermined formula that considers various factors, such as the employee’s financial needs and the performance of the company’s stock. Once the plan is in place, you cannot alter it or decide when to sell shares unless you voluntarily decide to end your participation in the plan itself.
How does a 10b5-1 plan work for selling restricted stock?
To establish a 10b5-1 plan for selling restricted stock, you’ll want to work with your employer’s HR department to get details on participating in the plan. The plan will specify the number of shares to be sold, the timing of the sales, and the price at which the shares will be sold. The plan will also include provisions to ensure that you do not have access to any material, nonpublic information at the time of the sales.
A plan administrator, typically in cooperation with your broker, executes the trades according to the established plan. The trades, more often than not, are conducted on a predetermined schedule, and you’ll have no ability to make decisions about when to sell the shares. Again, this approach helps to ensure that the sales are conducted in an orderly and transparent manner and that there is no appearance of impropriety.
Finally, if a 10b5-1 seems too complicated and doing nothing with your shares seems like a good enough plan, you may want to think again.
That’s because while we hope that the price of your company stock will rise over the long run, you’ll likely receive little financial benefit from shares that fall in value after vesting in the short run.
How so? Well, let’s look at an example:
Let’s assume that you have an effective tax rate of 25%, you’re the recipient of a restricted stock award that settles in stock, it’s the end of the year, $100,000 worth of your award has just vested, and your employer withholds enough stock to cover all of the tax related to this award.
At this rate, your $100,000 award nets you $75,000 worth of company stock after-tax.
So far, so good, right?
Well, if you do nothing with the stock, its value will either rise or fall with the markets.
So, let’s assume for a moment that current market conditions today are similar to what we experienced in 2022 and the value of your company stock falls by 25%.
Where does that put you?
Well, if you decided to hold onto your company shares in the down market, the value of this holding could be worth $56,250. The downside here is that if you were planning to use that money for the downpayment on a new home, to pay for childcare expenses, or otherwise supplement your living expenses for the year, then you’d likely be down nearly $20,000 for the year.
While selling your restricted stock outright is one option to avoid this outcome, so is diversifying your holdings into a basket of low-correlation assets to avoid some of the risks of holding a concentrated stock position. And if your plan was to hold your company stock for the long term, then having an appropriate cash management plan in place would also have helped avoid unnecessary shortfalls for your big-ticket spending needs.
Either way, having an appropriate action plan in place after your restricted stock vests can help you preserve your wealth and avoid unnecessary headaches down the road.
Make the Most of Your Restricted Stock this Bonus Season
Make no mistake, restricted stock is likely to be a valuable component of the total compensation that many employees at publicly traded tech companies receive. By providing you with an opportunity to benefit from the growth of the company, offering some tax benefits, and serving as a retention tool, restricted stock can serve as a significant portion of your overall compensation package if you work at one of these companies.
Even so, the devil is in the details when it comes to your awards. That’s why you’ll want to evaluate your stock plan to understand the terms of your grant agreement when you receive your award. More specifically, you’ll want to pay particular attention to the vesting schedule and the conditions that need to be met for the restricted stock to vest.
At the same time, you’ll want to be aware of any tax implications associated with your restricted stock, as they will be subject to taxation when they vest. It’s also vital to understand any restrictions that may be placed on the restricted stock, such as the inability to sell or transfer the shares until certain conditions are met.
When it comes down to it, however, taking these steps will help you make the most of your restricted stock this bonus season, but most importantly, it will bring you one step closer to mastering your journey to financial independence.
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