Who doesn’t love rewards? Especially if you get it from your employer in appreciation of your performance! Incentives, whether in cash rewards or company stocks, are a great way to boost an employee’s performance. Restricted stock units or RSU are one such type of incentive and also amongst the most popular ones.
However, there are some technicalities to this concept that need to be understood. Let’s learn some essential facts and basic concepts about RSU.
This article covers:
- What are restricted stock units (RSU)?
- What is a vesting period?
- What to do with RSUs after the vesting period ends?
- Benefits of RSUs
- Drawbacks of RSUs
What are restricted stock units (RSU)?
A Restricted Stock Unit is a type of added remuneration offered by an employer to employees. The employing company grants a few of its company shares to select employees.
The reason the grant is called ‘restricted’ is that it is subject to a vesting period. Legally speaking, vesting refers to a right to a present or future reward, payment, income or asset. A vesting period is predetermined and until then, the employees who have received RSUs cannot liquidate the shares.
To state simply, you receive the shares only after the vesting date.
Generally, companies choose to grant RSUs in a phased manner. For example, let’s suppose a company grants 200 RSUs with 25% RSU vesting every year. As such, you can claim 25%, i.e., 50 shares at the end of the first year, and then another 25% or 50 shares in the second year, and only at the end of the fourth year will you receive all the 200 shares granted to you.
Let’s suppose your company grants you 2,000 RSUs when the market price of its share is Rs. 25. By the time the grant vests, assuming the stock price has dropped to Rs. 20, the grant is then worth Rs. 40,000.
What is a vesting period?
Vesting periods are often time-based. As a beneficiary of RSU, you cannot leverage them unless the vesting schedule ends.
For instance, if you are eligible for RSUs at your company and you’ve been allotted certain shares for the same, your vesting period for RSUs is most likely subject to the completion of some metric or future achievement, measured most directly in a specified number of years spent at the company.
Usually, job termination stops vesting. However, there are exceptions—in situations like death, disability, or retirement, subject to your plan and grant agreement—vesting may be allowed to continue or may be accelerated.
What to do with RSUs after the vesting period ends?
After vesting is complete, you can sell them at your discretion. You may sell some or all of the stocks for substantial profit, should the market price have gone up. You may also choose to hold the stocks for the long term.
Note that there are certain tax liabilities associated with RSUs. Firstly, the entire value of vested RSUs is part of the ordinary income in the year of vesting. Furthermore, if you sell RSUs within two years of acquisition, the sale value is added to the income tax amount, and the RSU is taxed based on the applicable slab.
If you sell RSUs within two years, taxes are applied as per the norms of long-term capital gains.
Benefits of RSUs
There are several benefits of RSUs from an employer and as well as an employee point of view. Here are a few you should consider:
- RSUs provide added incentives for employees to remain with a company longer than a typical employment contract would.
- Since they are typically offered by fast-growth companies, they are an incentive for those seeking a higher-growth trajectory in their careers.
- Employees that hold on to RSUs are potentially eligible for phenomenal capital gains when the company’s stock appreciates.
- Contrary to stock options or warrants that may expire, RSUs will always carry value based on the underlying shares.
Drawbacks of RSUs
Along with the many benefits, RSU also has certain demerits. Let’s find out:
- RSUs are not eligible for dividends until they have been converted to actual stock. As an employee, you forfeit your shares in the company if you move to another organisation before the end of the vesting period.
- Like all other illiquid assets, RSUs can be considered actual returns only when they are realised, i.e., liquidated – sold. They can’t be pledged for cash or used as financial consideration during emergencies.
Restricted Stock Unit as executive compensation became more popular in the mid-2000s. It is to appreciate and honour an employee’s loyalty and commitment. For those who are eligible, RSUs can lead to windfall gains if held for the long term. The taxation rules governing ESOP and RSUs are the same as they all deal with stocks.
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