1. What are RSUs?
Restricted stock units (RSUs) are a form of equity compensation for employees. It is a promise from your employer to give you shares in the company in the future. RSUs are a popular form of compensation at large technology companies, including Microsoft, Amazon, Intel and Google.
Over time, RSUs can become a significant part of your overall income and net worth. So, it’s critical to understand how they work, how they are taxed and have a strategy in place for managing them.
How do RSUs work?
RSUs are awarded to employees at key events. Many large technology companies, including Microsoft and Google, provide new employees with RSUs when joining the company. They may also be awarded annually or depending on company performance.
With RSUs, there are two key dates to bear in mind, the grant date, and the vest date. The grant date is when the RSUs are awarded. The vest date is when the shares become available and can be sold. Typically, RSUs vest in tranches, rather than all at once.
For example, assume that you start working at Microsoft in January 2021. When you join the company, you are provided with 100 restricted stock units, with a four year vesting period. Each year, 25% of the RSUs vested. For every year thereafter, you are awarded an additional 100 restricted stock units.
In this example, 25 shares will vest after one year, a further 25 after the second year and so on.
For each additional year that you work for the company, you are awarded an additional 100 restricted stock units. This creates a ‘vesting cliff’, which means that a single year contains multiple vesting periods.
How are RSUs taxed?
There is no tax to pay when RSUs are granted. You only pay tax on RSUs when they vest. The UK tax treatment for RSUs is similar to how your salary is taxed.
You will pay income tax and national insurance on the value of RSUs vested. You will also pay employers national insurance. This will be based on the value of the RSUs once they vest (not the value when they are granted).
The below example calculates the tax you will pay at vesting. It assumes that you earn a salary of £150,000 and receive RSUs of £50,000. After tax and national insurance, your RSUs will be worth £22,843.
In most circumstances, tax will be paid before you receive the shares (i.e. you will receive the net amount after withholding taxes).
How can I reduce tax on RSUs?
You can reduce how much tax you pay on RSUs by paying into your pension. This is because paying into a pension reduces your ‘adjusted net income’ for tax purposes. The lower your income, the lower the tax rate.
For example, assume that you earn £100,000 and receive RSUs of £25,000. This gives you a total income of £125,000. Due to the 60% tax trap on income at this level, you will pay income tax at 60%.
However, if you pay £25,000 into a pension, for tax purposes you will have earned £75,000 and receive RSUs of £25,000. This gives you a total income of £100,000 and means that you will only pay income tax at 40%.
The below table shows that by paying £25,000 into a pension, you will save £4,310 in taxes.
Do I pay Capital Gains Tax on RSUs?
Once RSUs vest, you can sell the shares immediately. There will be no additional taxes to pay if you do this. However, if you decide to hold onto the shares, you may pay capital gains on RSUs.
If the value of the shares increases between when they vest and when you sell them, you will have made a capital gain. Depending on how big the gain is, you may need to pay capital gains tax.
Everyone has an annual capital gains tax allowance. For 2020/21 this is £12,300 per person. If the gain exceeds this, you will pay capital gains tax at 20% if you’re a higher rate taxpayer (10% for basic rate taxpayers).
How can I minimise capital gains tax?
There are two ways to minimise capital gains tax. The first is to sell the shares immediately upon vesting. This ensures that there is no gain to tax. If you still want to hold the shares, you could buy them back in a stocks and shares ISA. This ensures that any future growth is tax-free (although a reduced withholding tax may apply). If you hold the shares within a SIPP, any future growth is tax-free and no withholding tax will apply (assuming that your pension administrator has set it up correctly!).
The second way is to transfer some of the shares to your spouse. This is particularly useful if you have accrued large gains on the shares since vesting. There is no tax to pay when transferring shares to your spouse, thanks to the inter-spousal transfer exemption. Your spouse can then sell the shares, making use of their capital gains tax allowance.
In effect, you can sell double the amount of shares before capital gains tax becomes payable.
What should I do with my RSUs?
For most people, the best thing to do is to sell their RSUs immediately upon vesting. At a minimum, this ensures they don’t build up a future capital gains tax bill.
But more importantly, it reduces the risk if things go wrong. By owning shares in your company, you are effectively doubling down on your employer. If things go badly, not only does your stock go down, you may be out of a job as well.
Think about it this way, if you were paid a cash bonus, would you invest it in your company shares? If the answer is no, then you should probably sell your shares and invest elsewhere.
How can we help?
As independent financial advisers, we can advise you on the best way to manage your RSUs. We can help you to create a simple, easy to implement and tax-efficient strategy for your RSUs, as well as provide a broader review of your finances.
To review your financial situation and provide tax planning advice, we charge a fixed flat fee.
If you want to discuss working together, you can book in for an initial consultation.
All the best,
James Mackay, Independent Financial Adviser in Bristol
Financial Advisor Bristol and Pension Advisor Clifton
About us: Frazer James Financial Advisers is a financial advisor, based in Clifton, Bristol. As an independent financial adviser, we’re able to provide independent and unbiased financial advice. We provide independent financial advice, pension advice, investment advice, inheritance tax planning and insurance advice.
If you would like to speak to a Financial Advisor, we offer an Initial Financial Consultation without cost or commitment. Meetings are held either at our offices, by video or by telephone. Our telephone number is 0117 990 2602.
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This article provides information about investing, but not personal advice. If you’re not sure which investments are right for you, please request advice.
Remember that investments can go up and down in value, you may get back less than you put in.