What to do with my RSUs
James Schofield - May 18, 2023
Find out how RSUs work as a stock-based compensation and strategies that can be used with it to help build a retirement nest egg.
Public companies often use various stock-based compensation plans as a way to reward employees and create loyalty to the company. Restricted share units (RSUs) are a common form of stock-based compensation and can become quite valuable over a short period. Here we will explain how RSUs work and tax strategies you can use to start building a retirement nest egg as they vest.
Here is an example to illustrate how RSUs work: ABC Company grants an employee (Rick) 100 RSUs while its stock is trading at $300. The shares will vest over two years with the first vesting cliff set one year from the initial grant date, meaning he has to wait one year before he can sell any shares. The vesting periods are usually between 1-2 years and can include various cliffs, where a certain percentage of the original shares will become available to sell. For example, the company may stipulate that 50 RSUs will vest on the first anniversary of the initial grant date, and the remaining shares will vest quarterly over the next five quarters.
Once the RSUs have vested, the company will generally present the option to keep all the shares (after withholding tax), sell all, or sell some and hold some shares. In Rick's situation, let's assume the shares are now worth $1,000/share. At the first vesting cliff, he would receive 50 shares, but tax will be withheld immediately, usually at the highest marginal tax rate meaning the company sells approximately 26 shares to cover the tax before Rick even sees the money, leaving Rick with 24. It is important to note that the total value of the vested shares will be included on Rick’s T4 in addition to his salary and the tax withheld. Again, using Rick's example, the 50 vested RSUs increase his income by $50 K (assuming the share price is $1,000 on the vesting date). If Rick's salary is $100 K, the additional $50 K of income will push him into a higher marginal tax bracket. However, Rick will likely receive a large refund of some of the tax withheld on the vesting date, since the tax withheld was 53.53%, but should have been only approximately 44%.
Next, Rick will have to decide what to do with the remaining shares. We work with some clients who become emotionally attached to their company’s stock, but we often recommend selling the stock to diversify or spread out their risk. Although the share price could double after Rick sells, it could also get cut in half. If you have more unvested options, you'll benefit from the growth of the shares while you wait for the next vesting dates, and if it loses half of its value, at least you preserved a significant amount by selling half of them when you could. To help make this decision, we often tell clients to pretend they have cash instead of the shares and ask what they would do with the money; if the answer is anything other than "buy my company's stock," our advice will be to sell the shares. Why? Because there is no inherent tax benefit to keeping the shares, if there was, it could change the decision.
Depending on your tax bracket, contributing to an RRSP can be an excellent use of proceeds from vested RSUs. As mentioned earlier, vesting RSUs push employees into a higher marginal tax bracket but any contributions to an RRSP will reduce the employee's income when they file their T1 return. For people who live within their means, the sudden influx of $20 K-$30 K from vested RSU may be a pleasant but unexpected surprise and an opportunity to make a lump sum RRSP investment. Before rushing out to buy a new car, consider that putting this lump sum into an RRSP will result in a significant tax refund in most cases.
We have seen some cases where employees have had RSUs vesting quarterly for several years, but have never taken any action. In a few such cases, the shares have doubled or tripled in value after the vesting date. It is important to know that the sale of these shares will trigger capital gains tax. When RSUs vest, the price on the vesting date becomes the cost base, and the growth in value from the vesting date to the eventual sale date is a capital gain. In Canada, capital gains are taxed at 50%. While this may feel like you are paying tax twice, remember that paying capital gains tax means your investments made money.
An added benefit to making consistent RRSP contributions with RSU proceeds is that by establishing a pattern of receiving a large tax refund, you can request through the CRA to have your employer reduce the amount of tax withheld on your regular pay. The idea is that instead of waiting a full year to get your refund, which is the government returning your own money to you, you can increase your monthly cashflow by reducing the source withholding tax from your paycheck. For example, instead of receiving a $24 K refund one year, you could instead choose an increase of $2,000 to your monthly income, which can pay down debt, invest or help offset any increase in monthly expenses.