The Best Guide to Understanding RSUs

Summary:

RSUs are stocks that companies issue towards employees. RSUs promise to give employees shares of the company’s stock in the future, incentivize them to stay longer and contribute to the company's success. While they’re advantageous, they also come with their drawbacks. It’s best to understand the nuances of RSUs to reap maximum benefits.      

Restricted stocks are company shares that are issued to employees or other individuals. They come with certain restrictions or limitations with ownership and transferability. 

However, to know what they have in store for you, gaining a clear understanding of RSUs is import. Let’s take a closer look in this blog to help you understand better.  

What is an RSU? 

RSUs are a type of equity compensation that several organisations give their employees. Essentially, it’s like a promise from an employer that an employee will receive shares of company stock in the future. Now, let’s dive deeper and understand its intricacies.  

How does an RSU work?

RSUs can act like an incentive for employees to stay longer and improve the company’s performance. If the company does well, the price of the stock increases, and so does the employee’s RSU making it a win-win. Typically, the organisation releases a set number of company stocks on a vesting (time from when members initially receive RSUs to when they gain access to the real stock) schedule. The company assigns RSUs with a fair market value at the time of vesting.  

Typically, the recipient cannot collect the RSUs until they satisfy the provisional conditions. But remember, while employees get a stake in the company, RSUs are of no tangible value before they vest. Generally, restricted shares begin to have value once they start vesting. If the benefactor infringes the restrictions, like say, leaves the company before the vesting period, it means forfeiting the remaining RSUs.  

Let us take an example for more clarity.  

Employee A gets an offer of employment that comes with 2000 RSUs with a vesting period of 3 years. 

So, after the first year, the employee become the owner of 33% of the RSUs (~660 RSUs) that vest. The following year, 33% of the remaining RSUs (~660 RSUs) will vest, and in the final year the rest 34% (~680 RSUs) will vest. 

This means if the employee continues with the company till the end of the three years, they will be the owner of the entire set of 2000 RSUs. This becomes like any other stock someone would own. At this point, you can choose to hold on to them, sell them or make any other investment decision based on your financial goals.   

At the time of vesting, the value of the RSU will depend on the company’s current market price. If there’s an appreciation in the price, that will reflect in the final value of the RSU. Now, let’s take a quick look at the pros and cons of restricted stocks.  

Advantages and disadvantages of RSUs

Here are some of the advantages of restricted stocks: 

• Retention incentive – It can be an effective way to encourage employees to stay with the company for the time of the vesting period. This is beneficial for both the employee and the company. 
• Stake of ownership - RSUs give employees ownership stake in the company, which can make them feel more invested in the organization’s performance and success. 
• Better than stock options - With stocks, you need a larger share to receive the benefits that RSUs provide. 
• Simplicity – The general rules of RSUs are relatively easy for everyone to. You don’t need any prior or specialized knowledge of the stocks to make the most out of RSUs. 
• Potential for growth - During the vesting period, if the company’s stock value increases, so do the RSUs. 

While there are advantages, here’s the flip side:

• Restricted liquidity - Until the end of the vesting period, you can’t sell the shares and gain access to liquid cash. 
• Market risks - The RSUs value is linked to the company’s stock price, which can be variable. A decline in stock price results in lower valued RSUs. 
• Taxation upon vesting - When the RSUs vest, the employees still must pay all applicable taxes on their share like taxes on capital gains. 
• Limited control - While RSUs represent ownership, unlike actual shareholders, employees have limited influence or control over company decisions. 

Taxation effect of RSU in India

RSUs in India are taxed based on the country’s tax laws. Essentially, employees are taxed when the stocks vest, and not when they are offered the RSUs. On that date, the fair market value (FMV) of the shares is treated as taxable income and added to the individual’s regular income. 

At the time of vesting, employers are responsible for deducting Tax Deducted at Source (TDS) on the RSUs' FMV. If an individual sells their RSU, any gains are subject to capital gains tax. 

The bottom line

While RSUs are an excellent tool that will help you accumulate large sums over a long period, the benefits also depend on your career and financial goals. As a recipient, you should carefully weight out the benefit to the applicable restrictions and see if it makes good financial sense in the long term.