5 Advantages of Restricted Stock – and What That May Mean For You
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.
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.
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.
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, Tax is simple to calculate
When your Restricted Stock Units vest, it is simple to work out the tax that you will pay.
The total value of the share vesting is treated as income by the Australia Tax Office (ATO) and therefore, to calculate your tax liability for the year, you simply need to work out how much you have had vested in shares throughout the year and times this amount by your tax rate.
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 you are on the top marginal tax rate of 45% (there are levies etc on top of this), the tax is $45,000
If you are not sure how this may effect your situation, reach out.
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.