Three Step Process to Diversify Your RSUs

Here’s a three-step plan on how we think clients should handle RSU compensation. And this is how we instruct and walk our clients through the process. When we talk to clients, we find this is one of the stumbling blocks for a lot of our clients. They are kind of frozen in fear about what to do with RSU stock compensation. Read on to learn our three step process to diversify your RSUs. 

STEP ONE

The first step in your plan is to determine your level of risk tolerance. 

That may sound like a complicated exercise. But one way to think about it is to determine what you would feel like if the stock doubled today. How many shares would you want to hold? Well, the answer is a lot of them! All of them, right? If we knew it was going to double. 

The other part of that exercise is how would you feel if your stock price went down to a dollar? Or it became worthless? How would you feel if you didn’t sell some of those shares today? When they had value versus tomorrow when they might not have any value.

Going through those kinds of thought exercises can help you determine a level of shares that you feel comfortable taking a bet on. Because really this is kind of like gambling. The stock market, in general, if you own a broad group of diversified assets, we hope goes up over time. History has taught us that it does. But when you hold one stock, I liken that to the roulette table. You’ve kind of taken a spin at the wheel. Sometimes it works out. Sometimes it doesn’t. So no matter how good you might feel about the company having worked there, history is littered with examples of situations where everybody felt good until the last minute and the company stock dropped to little to nothing or went through a bankruptcy proceeding.

Summary

So you’ll go through that exercise and determine how many shares you’re comfortable with holding. At the end of the day, part of your wealth is tied up in that company. And if you’re currently employed there, part of your other income (salaries and wages) is as well. Just remember if something happens to that company, you kind of got a double whammy there. You’ll want to keep that in mind as you’re setting your risk tolerance. 

STEP TWO

The second step, if you have more shares than desired and you’re continuing to receive grants, is to sell the additional shares as they vest. 

If you happen to be holding more shares than you feel comfortable with, and honestly, this is a vast majority of the clients that we talked to, then one of the quickest ways to start to right that ship is to sell additional RSUs that are vesting. If you’re continuing to receive grants, they’re vesting over time, and you’re owning more shares as time goes on. Sell those shares as they are becoming vested. A lot of times clients are scared to do this because they’re worried about the tax consequences. It’s important to think through how this impacts you from a tax perspective.

Keep in mind that once those RSUs vest, whatever the value is on the day that they vest, it becomes income to you at ordinary income rates. That means that income is treated in a lot of the same ways that salaries and wages are as well. So you’ve already received the income related to those shares at the value that they were worth on vesting day. And therefore, if you were to sell those shares immediately (either that same day, the next day, that week), assuming the stock price doesn’t change a whole lot in between the vesting time and the sale date, you would have little to no additional tax consequences related to that sale. That’s very important to remember. And a lot of times clients are unclear about that. But you can go ahead and sell those shares with not much additional impact in most cases.

Summary

That’s step two – try to stop the bleeding. Go ahead and sell those shares, the new ones, as they’re coming on board.

STEP THREE

The third step is to put together a plan on how to sell the remaining shares over time.

You’ve got shares that you’ve been holding onto so you need to develop a plan for them. Let’s assume you still have more shares than you’re comfortable holding. I encourage you to put together a plan for how to sell those shares over time. This is where things become a little bit more complicated. If you’re not familiar with your tax situation and how capital gains work in relation to that tax situation, this is where it’s helpful sometimes to have a tax advisor on your side that can help walk you through this. There are some things to keep in mind:

• If you have a lower income year relative to other years, that can be a good year to sell stock if there is a gain
• If you also have capital loss carry-forwards, you can look to sell a number of shares to help utilize those capital loss carry-forwards

Those are some of the things we look for when we’re advising clients. Otherwise, you just might be in a situation where there are going to be some capital gains, and we just have to deal with that.

If you expect your income and tax situation to be relatively the same over a number of years other than the RSUs and your tax situation is not terribly complicated, then it’s really just a matter of deciding how quickly do you feel like you need to sell the shares in order to be able to diversify your assets. Are you comfortable taking that tax hit all in one year? Or do you spread it out over a couple years and take advantage of the time value of money? That’s a very personal decision. One that you’ll have to make on your own.

However, nine times out of ten, what we’re determining for clients is perhaps that they just don’t sleep well at night, given the number of shares they own. So developing that plan, having it in place and knowing when you will sell those shares can help you sleep at night regardless of the tax impact.

Summary

When you do sell those shares, make sure to estimate your taxes. Capital gain is going to be calculated based on the ultimate sales price minus the cost basis. Cost basis is really just the value for RSUs (the value of the stock when it vested). You should be able to find that in reports within your custodian’s system. Be looking for something that says cost basis. You could be subject to capital gain taxes anywhere from about 15% to 23% on the federal side. And if applicable, add your state tax rate to that. Remember that’s only computed on the gain, not the whole sales proceeds. Make sure you take into account your cost basis in the capital gain computation.

And make sure you’re setting aside some cash for those taxes. The last thing you want to do is spend that money or divert it somewhere where it’s harder to get. Then come April 15th, you’ve got a larger tax bill than you expected. For our clients, we’re doing that tax computation right now and helping clients get ahead of that. 

Final Thoughts

If you’re worried about a situation like that or you’re unsure what your tax situation is going to look like come April 15th, feel free to reach out to us. That’s why we’re here. We do tax projections for clients all the time to help them from a cashflow budget standpoint. We’d be happy to help you out as well. We hope this was helpful for you in developing a framework of steps you can take to diversify your RSUs.