Manage Vested RSUs Like A Cash Bonus & Consider Selling

Manage Vested RSUs Like A Cash Bonus & Consider SellingIf your company gave you a year-end bonus of $100,000, would you use all of it to buy your company’s stock?

Hell, no.

Yet, scores of our clients who own restricted stock units and work for Facebook or Google effectively have. You see, restricted stock units (RSUs) are taxed differently than stock options, and many employees who receive RSUs don’t understand the implications. Stock options have a tax advantage: they are taxed when you exercise, so you might have an incentive to sell the following year and take the gain or loss.

Not so with RSUs. They are taxed at the time they are vested, not when you sell. Facebook, for instance, even withholds the taxes due on RSUs by keeping 45% of the shares you have vested. The remaining 55% are issued with a cost basis equal to the price of Facebook stock on the day they were vested.

If you chose to hold on to your vested shares, you have, in essence, bought Facebook stock at the current market price. That means you should make the decision to sell them based solely on the stock price at the time of vesting and whether that large an investment in your company’s stock makes sense in your financial life.

Now you understand why we say holding on to all your vested RSUs instead of selling some is the equivalent of investing all of a bonus check into your company stock.

Cognitive Dissonance

I’ve tried the bonus analogy on a number of Facebook engineers I know. They understand what I’m saying, but some of them still hold on to all their vested RSUs. They are probably experiencing what psychologists call cognitive dissonance. That is the state of discomfort that arises when you hold two inconsistent thoughts, beliefs or attitudes in your mind, especially those that affect behavior.

Cognitive dissonance arises when there is an underlying emotional bias or addiction that keeps you from acting rationally. The classic example is the way a smoker thinks about her nasty habit. Every smoker knows smoking is potentially lethal yet keeps smoking. To ease the dissonance, the smoker comes up with all kinds of reasons that smoking won’t kill her, like “my genes are good,” or “I’m not a heavy smoker.”

A cost but no benefit

In the case of the RSUs, the reason for the dissonance might be regret aversion. (Our new advisor, Meir Statman, the Glenn Klimek Professor of Finance at the Leavey School of Business, Santa Clara University, helped me understand this.)

Consider the results of two experiments in which people were asked to exchange lottery tickets and pens. If you give people a set of lottery tickets, and ask them to exchange the first set for a second set, the answer will most often be “No.” If you give them a set of pens, and ask them to exchange the first set for a second set, the answer will most often be “Yes.” If one of the lottery tickets turned out to be a winner, you’d feel crushing regret. You hold on to the tickets because you want to avoid feeling regret.

A similar scenario might be unfolding with you and your RSUs.

You fear the regret you’ll feel if the stock shoots up after you sell it. That fear may be outweighing your rational view that you should diversify your holdings. Regret aversion causes people to keep what is theirs.

The fact that you’re working in a company with so many people in your situation could amplify your regret aversion. If your stock shoots up and the guy next to you decides not to sell, you’ll have to live with the fact that he was much luckier, and now richer, than you. But fear of loss and worry about future envy are not good bases for making financial decisions.

Cure for regret aversion

I have a few suggestions if you are stuck in the trap of regret aversion. You can realize the irrationality of your inaction, and sell the portion of RSUs you otherwise wouldn’t have purchased. It might help to make a pact with other people at your company facing the same challenge to increase the likelihood you’ll follow through on your intention to sell. If you’re not emotionally ready to sell, try the halfway approach, and dollar-cost average in reverse. Sell a fixed portion every month for the next few months. You’ll have an emotional cushion whether the stock goes up or down. If you are still vesting RSUs, you also can take comfort in the knowledge you have additional shares that could appreciate.

Only you can tell what you need to do to place yourself on the rational path. I’d just advise doing so. Consider your restricted stock units as you would cash. Sell all except the amount that you would have invested in your company’s stock had you received a year-end bonus. Maybe that’s 5%, or 10% , or 30% if you want to make a big bet, but I highly doubt it’s 100%.

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32 Responses to “Manage Vested RSUs Like A Cash Bonus & Consider Selling”

  1. Jaap Weel December 16, 2012 at 10:31 am #

    To make matters worse, the rational thing might be to underweight the industry you work in. If all my personal capital is in skills relevant to the software industry, I own real estate in Silicon Valley (which is highly correlated to the state of the software industry), and so on and so forth, the last thing I should want to do is to invest my money in… the software industry, right?

    • Andy Rachleff December 17, 2012 at 10:01 am #

      Your logic makes sense to us

  2. Muthoni December 22, 2012 at 11:37 pm #

    If you sell your RSUs in the year of vesting, aren’t your gains taxed as ordinary income?? On top of the taxes you already paid when they vested? I thought it was always best to wait another year post vesting to avoid getting taxed twice. Your thoughts on this would be appreciated

    • Andy Rachleff December 23, 2012 at 7:21 pm #

      The value of your RSUs are always taxed at ordinary income rates immediately at the time of vesting. The point we make in the post is that if you make money from that point on it is taxed as though you made a new investment. It only pays to wait another year if you think that is the best risk adjusted investment available to you.

  3. Nelson Bostrom January 5, 2013 at 11:01 pm #

    High level analysis, but since you used facebook and google employees … what if these RSUs vested at a price of $19? What if these engineers you’re referring to knew that they were reworking an add system to increase value to advertisers? What if they knew some major business development / sales initiatives were on slate?

    I know former google employees that were maxing out credit cards to buy stock in google.

    • Andy Rachleff January 6, 2013 at 5:25 pm #

      The advice still holds. How much would you be willing to invest in your company as a fresh investment. That’s the amount of your vested RSUs you should keep.

      It’s seldom a good idea to buy stock on margin, whether through brokerage loans or credit cards.

    • Viswa March 21, 2013 at 10:36 pm #

      “It only pays to wait another year if you think that is the best risk adjusted investment available to you.”

      Slight caveat to that. If I had bonus instead of vested RSU, then I have the freedom of making the best risk adjusted investment decision. I.e whether or not to put the entire bonus into company stock first of all. And secondly whether or not to sell it in the same year or risk waiting one more year to avoid short term capital gain tax.

      But in the case of vested RSU, there is lesser degree of freedom when making that risk/low tax decision. Let me explain. Its equivalent to I am forced to buy company stock on the day I got the bonus. That decision has been taken without my choice. Now, the only risk/benefit decision in my hand is whether to keep that stock until one more year and gain from long term capital while risking stock price going down, or cut down risk and sell immediately and take the short term tax loss. So lesser degree of freedom. I am already committed. So risk tolerance and optimistic view of future is more stronger. This is an added factor in addition to ‘regret aversion’ that you explained.

      • Andy Rachleff March 22, 2013 at 7:10 am #

        You don’t have to be committed. It is very easy to immediately sell that portion of the RSUs you don’t want to keep as soon as you receive them. As a matter of fact you can automate this process with a 10B5-1 program.

  4. Todd May 20, 2013 at 10:31 am #

    Let’s say I’ve got RSUs that have vested over time. I decide I want to sell. Is it better to sell off the ones that have a higher cost basis (in effect taking a loss) or sell off the ones that have a lower cost basis (maybe even getting a gain)?

    I didn’t “buy” any of them – they were given to me. And a share is a share. I *think* that means I’d be better off from a tax standpoint selling them at a loss rather than a gain, but I’m uncertain that my thinking is sound.

    • Andy Rachleff May 20, 2013 at 11:30 am #

      You are correct. You should first sell RSUs that have the highest cost basis. The further you defer taxes the better off you are due to the time value of money. Your highest basis RSUs are the ones that vested on dates when your stock was relatively higher than other vesting dates.

  5. Ryan July 7, 2013 at 7:08 pm #

    What do you recommend doing with the monies once RSUs are sold to prevent a lopsided portfolio? What about ibonds or an MMA to accrue small (based on current rates), but some interest?

    Is there another alternative that will enable liquidity and generate interest?

    • Andy Rachleff July 8, 2013 at 7:58 am #

      Wealthfront of course :-) We believe over the long term we should offer the best net of fee after tax returns

  6. Kate January 11, 2014 at 10:08 pm #

    If your company isn’t public (you can’t sell) and you have RSUs that are vesting – do you recommend allowing net settlement (i.e. company withholds some of your RSUs as payment for taxes owed at the time of vesting) OR paying those equivalent taxes with cash on hand so that you retain all RSUs vested?

    • Andy Rachleff January 12, 2014 at 4:14 pm #

      It depends on your company policy and your confidence in the likelihood the stock will appreciate post lockup. Most companies require net settlement. If your company does not and you think your employer is likely to meet or beat its first two revenue and earnings forecasts as a public company, maintain its revenue growth rate for a few years and expand its margins then it probably makes sense to pay your taxes with cash. If you don’t think your employer can do all three then I would go for net settlement. To better understand my recommendation, please read our blog post: Winning VC Strategies To Help You Sell Tech IPO Stock

  7. Jay January 30, 2014 at 10:08 am #

    My wife received RSU’s when the large tech company she works for went public last year. We know very little about this sort of thing, and apparently no one at her work does either. The only documentation she has received thus far is her W-2, which lists the RSU’s vested and added to her gross income. That same number is then listed as a deduction, described as “non-taxable compensation”. A co-worker seems to think this is the amount her company is withholding, but no one seems sure.

    Her company is allowing the sale of the RSU’s early, in February, to allow employees to cover there taxes.

    That’s where the confusion comes in. All we have to go by currently is her W-2. By that we get a refund, so why would we need to sell? Is there some information we are missing here, or do you have any other advice?

    • Andy Rachleff January 30, 2014 at 3:38 pm #

      Your wife should have received an RSU agreement when she joined the company that outlined the number of shares she received and the rate at which they vest. Her HR department should be happy to provide her with another copy. Typically RSUs vest over 48 months, so each month she will have additional shares transferred into the brokerage account her employer created for her for just this purpose. Most companies withhold the appropriate number of shares to pay the taxes due on the RSUs. RSUs are taxed at ordinary income rates which means it’s likely that 45% of the shares, the maximum marginal federal and state ordinary income tax rate, are likely to be withheld for taxes.

      For example if your wife had an initial grant of 2,400 shares that vest over 48 months then she would vest 50 shares each month. In this case her employer will likely withhold 22 shares each month for taxes which will leave her with 28 shares. As we explained in Manage Vested RSUs Like A Cash Bonus & Consider Selling, given the tax treatment on RSUs, a decision to hold the vested stock is the equivalent to deciding to purchase her employer’s stock at the current price (please read the post for more details). As with most tax related issues, we encourage you to consult with a tax advisor before you make any decisions. As luck would have it we just published a blog post today to help you identify the right tax advisor. Please email our cliet services team at support@wealthfront.com if you want some suggestions.

  8. Brian January 31, 2014 at 12:00 pm #

    I get your point, but it also depends on your company and the quality of your stock. What your investment plans are typically, etc. If my plan is to keep an investment account then you are 100% correct, I should take the RSUs once they vest and invest them where I want them. In my case, I don’t keep an investment account, don’t mess around with stocks and work for a top company, with stock that continues to grow better than expected. In my case, I hold the RSUs as my investment because they are longer term for me and will be used at a point when the cash is necessary. Good article though and appreciate the insight.

    • Andy Rachleff January 31, 2014 at 2:10 pm #

      That was the point we made in the post. Holding onto your RSUs is an implicit investment decision. If you believe the stock will appreciate then it could make sense to hold on, but the way to think about it is if you were given a cash bonus for the amount of value your newly vested RSUs represent, would you invest the entire amount in your company stock, because that’s what you are doing if you let it ride.

  9. Jordan Winn January 31, 2014 at 1:58 pm #

    This article, along with the comments, is very helpful. Quick question though. I’m doing a same day sale with my RSU’s on eTrade, and the number on there says to expect to be taxed on them 37.9%. My tax bracket is 25% though. Should I expect to be refunded the 12.9% margin on my tax return or what happens with that tax gap? Thanks so much!

    • Andy Rachleff January 31, 2014 at 2:08 pm #

      You should get refunded any extra taxes you pay. However the sale of your RSUs might push you into a higher marginal tax bracket. This is why we always encourage you to consult a tax advisor on issues like this.

  10. Dawn February 3, 2014 at 11:28 am #

    Hi Andy!
    Very informative article! My husband started a new job 18 months ago with a company that awards these RSUs. Although I have worked in the financial sector in the past, I had never heard of these, and we were both shocked to see them show up as income on his W-2. Since this has bumped us into a much higher tax bracket than in prior years, we are considering selling a few shares to cover this tax burden that we didn’t forsee. I have a couple of questions: 1) Are RSUs treated as regular stocks in terms of short term vs. long term capital gains taxes? 2) When determining the taxable value, will we be taxed on the entire Vested FMV (what I would call cost basis), or just the difference between the Vested FMV and the current market value on the day of sale? Thanks!

    • Andy Rachleff February 3, 2014 at 3:11 pm #

      It’s not surprising you have not had experience with RSUs. They only recently began to be used by private companies. We’re actually planning on publishing a post on the difference between RSUs and stock options in a couple of weeks.

      You should think of RSUs like a cash bonus. If you vest 50 shares each month and the price of the common stock is $60/share on the vesting date then you will incur a tax at ordinary income rates on the total value vested of $3,000 (50 * $60/share). For this reason most employers withhold a portion of the RSUs you vested to pay for your taxes. If you assume a 45% marginal tax rate then in the example I just gave your employer would keep 22 shares (.45 * 50 shares) and issue you 28 shares (50 – 22). Your W2 should show the value on the vesting date as income and the withheld shares as taxes withheld (22 * $60 = $1,320).

      If you choose not to sell your RSUs on the date granted then your cost basis for those shares will become the price on the date they were issued. In this example your cost basis will be $60. If you hold those shares for more than a year and then sell at $70/share then you will have a long term capital gain of $280 (28 shares * $10 long term gain). If you sell after holding on to the shares for less than one year post vesting at $65/share then you have a short term capital gain of $140 (28 shares * $5 short term gain). You can also recognize a loss if you sell below $60.

      As you can see there is no double taxation of profits. I hope this helps. As always we suggest you consult with a tax advisor begfore taking any action at least on your first vested shares. To see how to choose an advisor, please see 11 Questions to Ask When You Choose a Tax Accountant

  11. Rimsha February 3, 2014 at 5:00 pm #

    Great article, interesting read. I look at my RSU’s as a bonus also. I had a question, as an example: If I vest 1250 shares today, the “bonus” amount totals: 50,000. However if we exercise all 1250 shares, 25% is deducted through taxes, so we end up losing $12,500. In this scenario, is it still wise to sell as soon as the RSU’s vest? Or do we end up paying $12,500 in taxes even if we don’t exercise?

    • Andy Rachleff February 3, 2014 at 5:19 pm #

      RSUs aren’t exercised. Unlike stock options, you don’t determine when you incur the tax liability. You incur the liability as soon as an RSU is vested and is liquid. If you vest 1,250 shares today and your employer’s stock price today is $40 then you owe taxes at year end (and perhaps in a quarterly estimated payment) equal to the ordinary income tax rate times $50,000 no matter how much you choose to sell.

      As we explained in the article your decision re how much to hold should be based on how you would deal with a cash bonus. If the after tax value of your vested RSU is $30k ($50 – 40% taxes, your 25% is likely way too low on a marginal basis) then how much of a $30k cash bonus would you use to buy your company’s stock at the current price? For most people the answer is 0 – 10% of the after tax amount. In your example if you assume a 40% tax rate then you would be left with 750 shares. If you are like most people then you would keep no more than 10% or 75 shares and sell the rest (675 shares) immediately.

      As always you would be well served to consult with a tax advisor. We are happy to provide suggestions if you email support@wealthfront.com

  12. Makaveli February 18, 2014 at 7:33 pm #

    Appreciate the insight. As others mentioned, the comments and feedback have been as informative as the article itself so thank you for the quick responses.

    My story – I was granted RSU’s for the first time this past year. They are set to vest in thirds over a three year time period. This year I’ll be vesting my first third and have been contemplating the risk/reward of holding the shares vs. selling and diversifying. I like the thought process of treating it as a cash bonus (sell & diversify) but at the same time I have confidence in the company I work for (hold). I believe the upside outweighs the risk in my case since our company may be a potential candidate for a buyout. If so, stocks will instantly receive a 25%-50% bump. But rumors are rumors right? Decisions decisions!

  13. Allyson Hamilton March 3, 2014 at 7:51 am #

    My husband receives RSUs with his company as a bonus. We chose to have our taxes come out when the stock vests. We are considering using some of the RSUs for a car purchase. Does is matter if we use the ones he just received, or the ones he received last year? Will we have to claim the ones we sell on our 2014 income taxes if we already claimed them on our 2013 income taxes? We are very new to any stock options, so any advice would be appreciated!

    • Andy Rachleff March 5, 2014 at 2:54 pm #

      First of all RSUs are not stock options. I know this is a detail, but they are very different (please see our post How Do Stock Options and RSUs Differ?).

      Most tax advisors will tell you to first sell the stock that will trigger the lowest tax. Since long term capital gains are taxed at lower rates that means the one that has been held for over a year since it vested and became liquid. You should then look for the one with the highest cost basis.

      It is almost always a good idea to defer taxes (by selling the highest cost basis stock you will have the smallest gain and thereby incur the smallest tax) because you can earn a return on the tax you didn’t have to pay which lessens your burden in the future.

      Like all tax issues, we strongly urge you to seek advice from a professional tax advisor.

  14. Karen ODonnell Marshall March 10, 2014 at 7:31 am #

    Since the reply on March 5, 2014 says that RSUs are not stock options, does that mean that they do not have to be entered elsewhere on the federal tax forms? My question assumes that the RSUs are granted and vested, but not sold. Since their market value at time of vesting is included in box 1 of the W-2, I don’t think the market value at time of vesting should also have to be included separately on the AMT form, such as on line 14 (exercise of incentive stock options), or anywhere else on federal tax forms, but I am not positive of this. Reporting it elsewhere seems to me like you would be counting the same income twice.

    • Andy Rachleff March 10, 2014 at 3:14 pm #

      RSUs are counted as taxable ordinary income as soon as they vest and are tradable. For example if you vest 100 shares on February 28th and the price of your stock on the 28th is $30 then your taxable income for February is your salary plus $3,000. Most companies withhold the taxes due on your RSUs by reducing the number of RSUs you receive. If you choose not to immediately sell the vested RSUs then you will incur a future capital gain or loss on a cost basis of $30 per share. In this way you are not doubly taxed.

      I can’t tell you where on your tax form you need to enter the relevant information. It sounds like you could greatly benefit from a tax advisor. Our client services team (support@wealthfront.com) is happy to make recommendations. I also suggest that you read our post 11 Questions to Ask When You Choose a Tax Accountant.

  15. Sean March 13, 2014 at 2:01 pm #

    As luck would have it, I have some advice/info that others might want to hear. I also saw several advice columns mentioning using the stock as a bonus, which I did. Our company (public stock) was doing nicely, cash rich, buying companies, and doing really well in the international market.

    Then SWOOP, a much larger fish wishing to add to their bloated corporate profile came along and does an aggressive buy-out of our company. I had already sold my shares every quarter, but if I would have held onto them for the 6 years I was there, I could have made 8-10x the money with the 60% over the current stock price the company sold out for.

    So those executives “in the know” made out handsomely, because they had tons of stock in reserve they had not sold yet. Those who had piddly stock, like 3000-10000 shares, and selling each quarter, lost out on the endgame big payout.

    If I had the ability to send myself a message in time, I would say “hold onto all that stock” its free money anyway. Perhaps the question and advice I could give, is to check where you are at company-wise, and if your particular company is ripe for a takeover sale, regardless of what space you are in, and how well you are doing. How much stock do you have, can you afford to let some go for that “bonus” or should you just bite the bullet and hang onto it “in case” something interesting happens…

    I simply thought we were going to take over the world in our particular space, but now it seems that has been passed on to the much larger, hungrier fish.

    cheers.

    • Andy Rachleff March 14, 2014 at 5:02 pm #

      For every story like yours there’s more than 10 times as many who are worse off for following the strategy you propose. That’s why we didn’t recommend it in our post

      • JohnJay March 17, 2014 at 7:02 pm #

        Agreed. My company’s stock appreciates pretty regularly at 20% (up 4x since I joined 5 years ago) and the insiders sell massive amounts of shares all the time that come through RSUs – I think they wait for the ongoing new grants of RSUs as a way to take advantage of anticipated future gains. I agree with Andy – there are plenty of counter-stories to your story. You are giving an ‘investment story’ not an ‘RSU story’.

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