5 Advantages of Restricted Stock – and What That May Mean For You

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Key Points:

  • Restricted stock units or awards are one of the easier to understand and more straightforward of the many types of equity compensation that an employer can offer.
  • Restricted stock is granted to you by your employer and is then subject to a waiting period, after which time the stocks are said to “vest” and they become wholly yours.
  • The value of restricted stocks is calculated by multiplying the number of shares by the share price; however, this value is not locked in until the stocks vest and become yours.
  • When your stocks become vested, they are subject to income tax--including Social Security and Medicare--which your employer will automatically deduct from your payroll.
  • Because of the straightforward timeline and automatic payroll deduction associated with restricted stocks, there are fewer decisions that you need to make.

There are many types of equity compensation that an employer can include in an employee’s compensation package to attract and retain the best talent. Each kind has its own set of rules that apply to how that equity is managed, granted, and taxed. It’s important to understand these nuances if you have access to benefits like employee stock options or grants of company stock.

Restricted stock units and restricted stock awards (commonly referred to as restricted stock in this article) are common types of equity compensation granted to employees. They offer a future promise of uncertain value; the value based on the stock price of the company when the restricted stock vests.

Vesting is usually dependent on a specific vesting schedule, which generally requires you to stay employed with the company for a certain period of time before the restricted stock will vest. Once they do vest, however, the restricted stock goes from a promise to value you actually receive.

It’s essential to take the time to develop a clear understanding of how your restricted stock works and how it can benefit you. Once you do so, you can develop a better strategy for how to best manage restricted stock in your financial plan.

Here are the main benefits to be aware of for your restricted stock.

1. The Timeline of Restricted Stock Is Easy to Understand

One of the more attractive features of restricted stock is their relative simplicity compared to other forms of equity compensation. With restricted stock, the timeline of events is straightforward and easy to follow.

COMPARISON GUIDE

Not All Stock Offers are the Same! Here's a helpful comparison between two of the most common employee stock options.

Comparing Employee Stock Options vs RSUs cover

It often looks a little something like this:

  • Your employer grants restricted stock to you. Being granted restricted stock is not a taxable event.
  • Your restricted stock vest after you meet the vesting requirements, and you are taxed on the value of the units that day.
  • Some (or all) of the income tax due is withheld for you.

You receive shares of stock in a brokerage investment account (or cash if that’s an option and you select it; check your plan document to see what applies in your specific situation) equal to the value of these shares at vesting, less the amount withheld for taxes.

Once the shares are deposited into your brokerage account, you own them just like you went out and bought them yourself that same day. You can keep them, sell them, or do anything else that your ownership rights allow you to do.

2. Restricted Stock is Easy to Value

Restricted stock is one of the easier types of equity compensation to value. You can calculate the value of your restricted stock by multiplying the number of restricted stock awarded by the current fair market value of the stock:

Restricted Stock x Stock Price = Current Value

This calculation can be done at any time to value your restricted stock. Keep in mind that the value, as calculated above, is only a future promise. It remains this way until your award vests.

While everything could remain the same between today and your vesting date, it’s more likely that the value will change between now and then. Keep this in mind when planning a strategy around how you’ll use your restricted stock; the value today may be different than the value when the award vests.

3. Knowing When You’ll Receive Shares Is Clear, Thanks to the Vesting Schedule

When you receive restricted stock, they are, in fact, restricted. This means that you need to meet specific criteria for the restriction to lapse. Only after the restrictions are met or lifted can you claim the value of the shares.

Most restrictions are tied to the vesting schedule. For example, your company may award you 2,000 restricted stock units/awards — but they only vest if you remain employed with the company three years from the grant date. Vesting schedules can vary from one company to another, and you’ll want to confirm your specific schedule.

When the restricted stock does vest, you receive shares of company stock (or the value paid as cash; again, that’s subject to specific rules laid out in your plan document). Prior to meeting the restriction set by your employer during which time you have a substantial-risk-of-forfeiture, restricted stock is deemed unvested. The value of the unvested restricted stock is not taxed.

From a financial planning standpoint, vesting, and more specifically, the vesting schedule can help you to plan a strategy for the value of your restricted stock because you know when to expect them. This should allow you to make better decisions around tax planning, investment planning, and strategizing what to do when you have the option to act.

4. When Restricted Stock Vests, Taxes Are Often Withheld for You

When your restricted stock vests, it creates a taxable event. You will be taxed on the full value of the restricted stock as of the date of vesting.

For income tax purposes, the full value of vested restricted stock is taxed as ordinary income, subject to both Medicare and Social Security wages, as if it were the same as your typical wage income.

One advantage of restricted stock is that when the award vests, your employer commonly withholds income tax on the vested value. Employers will often also include the value of your vested restricted stock units in your W2 at year end.

Typically, employers withhold at a statutory rate of 22% on the vested value, plus the appropriate Medicare (1.45%) and Social Security (6.2%) rates if those apply, for a total potential withholding of 29.65%. (This does not include potential state and local tax.)

Using an example to illustrate how much tax may be withheld, let’s assume that you have the following:

  • Vested Restricted Stock: 2,000
  • Fair Market Value at Vesting: $50.00
  • Total Value of Your RSUs: $100,000

If we assume that a company withholds at the total 29.65% rate discussed above, we can calculate that $29,650 will be withheld when the shares vest. This means that you will receive the remaining value, or $70,350, in either stock shares or in cash.

It’s nice to know that at least some of your tax bill is being covered via the withholding. However, it may or may not be enough to cover your total tax liability, and you may still owe more.

If you are not sure how you may be impacted and whether or not you withheld enough, you may want to speak with your CPA about how this may impact your personal situation.

5. Restricted Stock Generally Requires Fewer Decisions for You to Make

Overall, restricted stock is easier to deal with than other types of equity compensation. That includes non-qualified and incentive stock options. One main reason is that several of the critical decisions are driven for you, not by you.

This is different than equity compensation types like employee stock options. With employee stock options, you must choose when (and if) to act on your options. That decision may be complicated by a number of items, including income tax, valuation, cash flow needs, and market timing.

All of these factors can leave even the most educated of investors confused and uncertain of what to do—possibly leading to no action at all because the onus is on them to act. That may be a potential problem because those options do expire.

For that reason, the forced decision-making tree of restricted stock can be seen as an advantage. The vesting schedule, the fair market value you receive, and some tax withholding happen without you needing to make any decisions or take actions. That automation can make it easier to actually take advantage of your equity compensation.

But while many of the decisions are made for you, you still need to remain engaged in the process. This is your restricted stock, after all — and you’ll likely still need to address some income tax planning questions during the year of vesting. You also need to make the decision of what to do with your newly owned shares once they vest.

There Are Many Advantages to Restricted Stock — Be Sure to Make the Most of Them

The overall simplicity of restricted stock, as compared to other forms of equity compensation, make them an attractive company offering. Restricted stock can also generally result in something of value for you as the employee (assuming the vesting periods are met) without requiring you to make a lot of decisions along the way to get to that outcome.

To make the most of this opportunity, take the time to understand how much value you have in restricted stock, how you plan to address income tax and cash flow post vesting, and how you plan to incorporate that value into your financial plan.

Even though some of the advantages of restricted stock make them easy to understand, making consistently good decisions with the value is vital to achieving a positive outcome.

This material is intended for informational/educational purposes only and should not be construed as investment, tax, or legal advice, a solicitation, or a recommendation to buy or sell any security or investment product. Hypothetical examples contained herein are for illustrative purposes only and do not reflect, nor attempt to predict, actual results of any investment. The information contained herein is taken from sources believed to be reliable, however accuracy or completeness cannot be guaranteed. Please contact your financial, tax, and legal professionals for more information specific to your situation. Investments are subject to risk, including the loss of principal. Because investment return and principal value fluctuate, shares may be worth more or less than their original value. Some investments are not suitable for all investors, and there is no guarantee that any investing goal will be met. Past performance is no guarantee of future results. Talk to your financial advisor before making any investing decisions.

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Hi, I'm Daniel Zajac, CFP®, EA

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Understand what you have, what you should consider, and what ultimately matters to you.

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