What You Need to Know About Restricted Stock Grants
If you are fortunate enough to receive a restricted stock grant (often referenced as restricted stock units or RSUs) from your firm as a joining or retention incentive, you should understand the fundamentals of this benefit. The terms surrounding the vesting and pricing of this stock grant may impact your decision-making for tax planning as well as ongoing employment.
Restricted Stock Unit Grants
When an employer offers you shares of the company but places limitations on your ability to access or monetize the stock, it is said to be restricted. These grants are frequently used in technology, high growth, and large established firms as a means of recruiting or retaining key employees.
Common Employer Restrictions
The most common form of restriction placed on these contributions by the employer is to delay access to the actual shares through a process called vesting. Consider a scenario where you are hired and offered 500 shares of stock, but vesting requires three years from your hire date. In this situation, you will be unable to touch the stock for three years. If you leave the firm before the three-year mark, your shares will be returned to the company. There are a variety of formats employers can use to pass ownership of the shares to the employee over time.
What Happens If You Leave Before Your Stock Vests
This point is worth the redundancy in this article. If you leave before the restricted stock unit grant vests, you forfeit the ability to gain the shares. This benefit essentially will have been worthless to you.
Restricted Stock vs. Stock Option Grant
Both have a vesting period; the difference is at the end of that vesting period. When a stock option vests, you have the option of purchasing or not purchasing the stock at a specific price (the strike price). You do not own any company stock until you exercise the option and purchase the stock. As soon as you purchase it, you can do anything you want with it, including selling it. When a restricted stock award vests, you own the stock, and you can do whatever you want with it.
Which Is Better?
The answer to this question is, "It depends." Generally, if the stock price is rising, stock options may be preferred. You can sell both at the higher market value, but with stock options, you have not had to commit to the purchase until the stock price reached the point at which you wished to sell. Alternatively, if the stock price stays the same or is trending downward, restricted stock may be better since you own the stock. Your un-exercised options have no value, and if the share price is below the strike price, they are effectively described as "under-water." The stock, of course, has some value unless it declines to zero.
It is possible your restricted stock unit grant will trigger a tax liability upon the vesting date, regardless of whether you have sold the stock or not. Be sure to consult a qualified accountant or attorney for the latest rules on the tax implications of your particular award.
The Bottom Line
It is important for you to understand all of the terms and tax implications of your particular benefit. Both options grants and restricted stock unit grants can be excellent vehicles for wealth creation over time. However, there is no such thing as a free lunch in finance. Certain restrictions will govern when and how you access your grant and tax implications always loom large when evaluating these employer contributions.
Updated by Art Petty