Like many pharma employees, you might be offered Restricted Stock Units (RSUs) as a form of compensation.
As I explained in a recent blog, RSUs can be a lucrative bonus that tend to be a bit more stable than stock options.
But when your RSUs vest and become shares of actual stock, you might wonder: now what?
Do I sell my shares and put the cash somewhere else? Or do I leave them be and hope the stock price grows?
Everyone’s situation is different – but in general, I think selling your shares is usually the right move.
There are a few reasons why…
RSUs Are Taxable
When your RSUs vest, those new shares are considered taxable income, valued at the current stock price.
Suppose you have 250 RSUs vest this year when the stock price is $50 a share.
Whether or not you sell your shares, that vesting event just increased your taxable income for the year by $12,500.
Thankfully, most employers withhold some vested shares to account for the tax obligation.
But here’s the problem: since the IRS considers vested RSUs to be “supplemental income,” the default withholding rate is only 22%.
In reality, your marginal tax rate could be as high as 37%.
Continuing with our example, the gap between the withholding rate and your actual rate could result in a surprise $1,875 tax bill come April 15th if you’re in the highest bracket.
If you sell a portion of your newly vested shares, though, you can set aside cash to pay for the pending tax bill.
If you’re curious about other ways to navigate RSU taxation, I discussed this topic in more depth in a recent video – although I highly recommend you speak with a tax professional for specific guidance.
Concentrated Risk
As an advisor, I’m a strong proponent of diversification.
In technical terms, you always want to avoid having too much money tied up in assets that are highly correlated with each other.
In practical terms, there’s a saying I like even better: don’t put all your eggs in one basket.
As an employee, your financial prospects are closely tied to your employer’s business prospects.
If the economy declines or your company starts struggling, layoffs could mean you find yourself out of a job – through no fault of your own.
If that occurs, the last thing you want is to have a big chunk of your wealth held in shares of your company.
Why? Because if your company needs to lay off employees, then the stock price probably isn’t going to be doing great either.
Thinking about stuff like this isn’t always fun, but preparing for the worst is part of building a resilient portfolio.
Here’s the bottom line: your financial wellbeing already has a lot of concentrated exposure to your employer.
That means selling out of your vested shares and reinvesting the cash into a more diversified basket of assets might be a smart move.
The Mere Ownership Effect
Finally, I want to talk about an interesting psychological quirk that can make people hesitant to sell their RSUs.
As investors, we’re subject to a cognitive bias called the mere ownership effect.
This effect was uncovered by academic experiments in which researchers split people into two groups and asked them to rate the same object.
There was a key difference between the two groups – people in the first group were given the object to keep, while people in the second group had to return it to the researchers.
Surprisingly, the experiment revealed that the first group consistently gave the object a higher rating than the second group.
Why? For no other reason than the fact that the people in the first group owned the object, while their counterparties in the second group did not.
When it comes to RSUs, the mere ownership effect means you might be tempted to hang on to shares for the wrong reasons.
Here’s the question I ask clients trying to decide whether or not to sell vested shares…
Instead of vesting your shares, imagine your employer gave you an equivalent bonus in cash. Would you use the money to go out and buy stock in your company?
For most people, the answer is: probably not.
And yet, holding onto your RSUs is the same as answering “yes” – because the two scenarios are exactly equivalent.
Only one, though, is impacted by the mere ownership effect.
So, What Should I Do?
Like I said, there’s no one correct answer for every situation.
In many cases, selling all of your vested RSUs makes the most sense.
But perhaps you feel very confident in your company’s future or enjoy having a sense of ownership in your organization.
We’ve only scratched the surface of RSUs here, and the details of this compensation program can vary from company to company.
If you have a vesting event coming up and want to speak about your personal situation, I’m always available for a one-on-one conversation.
And if you're having trouble with where to start?
Schedule a call with me.
It is only 30 minutes, doesn't cost anything, and there are no obligations to do anything after you call.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
Investing involves risk including loss of principal. No strategy assures success or protects against loss.
The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.
This information is not intended to be a substitute for individualized tax advice. We suggest that you discuss your specific tax situation with a qualified tax advisor.