Restricted stock units (RSUs): How do they work?

Restricted stock units, or RSUs, are a type of employee compensation that some companies may choose to give their workers. RSUs can be an alternative to other forms of stock-based compensation, like stock options.

RSUs are restricted during a vesting period. This is a time period during which the employee isn't allowed to sell the stock. They’re only allowed to sell it once the RSU is vested. Alternatively, they may choose to keep it, holding it like they would a share of any other company stock.

What is a restricted stock unit?

An RSU doesn't have tangible value until it's vested. Until then, it simply gives the employee an interest in the company's equity. The types of vesting plans for RSUs vary according to the specific conditions set forth by the employer.

For example, the employer might dictate that the employee's stocks are only vested once the company achieves a defined milestone, like a successful initial public offering (IPO). Or, for instance, that the employee's stocks are only vested after they've been with the company for three years.

Sometimes, vesting plans are a combination of time- and milestone-based factors.

Why do employers confer RSUs?

Employers may provide RSUs for various reasons. For one thing, employee equity can be a strong selling point for attracting top talent. This is especially useful if a company isn't in a place to pay huge salaries. Equity can be a good counterbalance—it’s one reason why many startups offer equity.

RSUs also incentivize employees to stay with a company and perform well. Since the vesting usually depends on the time spent with the company or performance-related milestones, the employee has the company's interests at heart. 

What happens to restricted stock units after termination? This results in the worker forfeiting their rights to any unvested shares. This fact exemplifies why RSUs can be such a great motivator in encouraging employee loyalty and improving retention. Individuals who are eager to access their RSUs will wait until they're vested before leaving.

For employees, RSUs can be an attractive part of a diversified compensation package. That said, there are some downsides. Employees won't get dividends until the stock is vested, for instance. Further, RSUs don't grant voting rights until the actual shares are issued. Plus, employees need to consider the tax complexities when the shares are vested and become transferable.

How are restricted stock units taxed?

The RSU is assigned at a fair market value when it vests. At this point, the RSU is considered income, which has tax implications.

How does taxation work for RSUs? A portion of the shares is usually withheld to pay the relevant income taxes immediately, and the employee then receives the rest. Since those shares are vested, the employee can do what they want with them—sit on them or sell.

What's the difference between stock options and restricted stock units?

Stock options are a better-known form of equity compensation. When an employee gets a stock option, they are given the right to buy a set number of shares. These shares are bought at the so-called exercise price or strike price, a pre-set price that's available for a set time period. Like RSUs, stock options can also be linked to a vesting period, usually time-based. 

So, what's the difference between restricted stock units and stock options? RSUs are popular because they have more favorable income tax treatment and accounting guidelines. Basically, stock options are taxed when sold or exercised. RSUs are taxed when vested.

What's the difference between restricted stock units and restricted stock awards?

Restricted stock awards, or RSAs, result in an immediate stock grant. An RSA isn't just the promise of free stocks in the future (assuming certain vesting conditions are met). The receiver owns actual shares of the stock as soon as they are granted.

The differences between restricted stock awards vs. restricted stock units also impact voting rights and dividends. If someone gets an RSA, they’re entitled to dividends and have voting rights as soon as the RSA is granted (assuming the shares confer voting rights). RSUs don't grant voting rights or dividends until the shares are settled.

The taxation of restricted stock units and restricted stock awards also varies. For RSAs, if the employee pays the fair market value for the shares, there aren't any immediate tax implications. However subsequent gains and losses are subject to capital gains tax.

For RSUs, tax implications are only triggered once the shares are vested and the employee settles the shares. See the section above for tax details on restricted stock units.

Disclaimer: This post and all information in it is provided for general informational purposes only. It does not, and is not intended to, constitute legal or tax advice. You should consult with a qualified legal or tax professional for advice regarding any legal or tax matter and prior to acting (or refraining from acting) on the basis of any information provided on this website.