Restricted stock units can play a valuable role in wealth and retirement planning – but how do you make the most of them?
Deferred compensation (or “deferred remuneration”) is a common benefit provided by businesses in order to attract and retain the best talent. For C-suite individuals at listed companies, this often takes the form of restricted stock units (RSUs).
In essence, RSUs are a promise from your employer to give you company shares at a later date. Shares are awarded, or “granted,” on one date, and then you receive them down the line on a vesting date (or dates).
Vesting is the process of gaining full ownership of an asset, meaning you don’t have full control over it until the vesting period has passed. Once it’s passed, the asset belongs to you and can be exercised and/or sold.
RSUs typically vest in one of two ways:
Shares are either given in physical format – which you can choose to sell or hold once they are vested – or as a “phantom” option, in which you are basically granted the cash value (without actually receiving the cash). Once the phantom shares are vested, you receive the cash value based on the share price at the time of vesting.
“One of the key advantages of RSUs is that they provide additional cash flow in the future,” says Nick Ritchie, senior director, Wealth Planning at RBC Wealth Management in the British Isles. “The challenge, of course, is how to best include that future income in a wealth-planning strategy.”
“Understanding the vesting schedule is the starting point when it comes to planning around RSUs,” explains William Sheard, director, Relationship Management at RBC Wealth Management in the British Isles. “If it’s cliff vesting, for instance, then you know you won’t receive your shares until the end of the set time period. When it comes to gradual vesting, planning tends to be on a more rolling basis.”
Ritchie adds, “The vesting schedule gives us a sense of a timeline as to when there might be cash flow, and how much that might be. If you’re a 45-year-old managing director whose RSUs are locked in for seven years, then you know you’ll be 52 before the first vesting period. So there might not be urgency around your planning, although we’d certainly recommend having an initial conversation with your adviser. If you’re going to receive your first set of shares in the following year, then you need to think about this now.”
Critical to wealth planning around RSUs is working out the net position of what is – or might be – paid out. However, there are two key factors that will have an effect on their value when vested. These are:
Over the time that you hold the RSUs, the share price of your company is likely to fluctuate. In an ideal world, the share price will increase, so your holding will be worth more when it vests. Of course, the share price may go down, which means your shares will be worth less.
Regardless of whether the share price has gone up or down, it’s vital to understand that when your shares vest, the value will be subject to both income tax and national insurance. It’s also important to note that if you received physical shares, you will be liable for tax whether you choose to hold or sell them. For higher earners, that could entail a higher rate of more than 50 percent .
“As a result, the value of your shares at vesting can take a significant ‘haircut,'” says Sheard. “This is why we often advise our clients not to be reliant on that cash flow until it actually arises, or until they have a better view of what the outcome may be.”
If you’ve been given physical shares and decide to hold them, there’s also a risk that capital gains tax may become payable at a later time.
While the tax implications are a drawback of RSUs, there are ways in which these can be mitigated.
“One option would be to look at tax-advantageous investments, such as Enterprise Investment Schemes,” says Ritchie. “By taking a portion of the income from the shares and investing it into growth companies, there are valuable tax reliefs available that can help minimise the tax hit.”
It’s also possible to decrease your overall tax liability by making a pension contribution out of your salary relative to the value of the RSUs, as this can reduce your adjusted net income and possibly move you into a lower tax bracket.
If you want to retain shares in your company, you may be able to minimise capital gains by selling the ones that have vested and then buying them back in a stocks and shares Individual Savings Account (ISA), so that future growth is tax-free (a method called “bed and ISA”). Alternatively, you could transfer shares to your spouse – using the inter-spouse transfer exemption – who could then sell them using their capital gains allowance.
Unsurprisingly, tax mitigation such as this can be complex, which is why consulting a tax adviser to work out your likely net income from vesting is essential.
While it’s important to keep the above in mind, the reality is that RSUs are going to form a part of much broader wealth planning. When they are vesting annually, for instance, they may have a direct impact on ongoing wealth-planning decisions.
Conversely, knowing that the cash flow may continue for some time can also help in the longer term, such as with retirement planning. “Take the managing director who joined a firm at 45 and is now 60 and ready to retire,” says Ritchie. “If their RSUs are on a seven-year vesting schedule, they know they’re going to still be receiving cash flow seven years into their retirement, which means they can use it as the basis for retirement planning.”
This could mean that if they have other savings and investments allocated to retirement, they can keep those invested, earning long-term growth, while relying on deferred payouts in the shorter term.
It’s also critical to note that deferred compensation could well form part of your estate. “This is often overlooked because people can think it’s not actually worth anything until it’s paid,” says Sheard. “Yet there could be hundreds of thousands of pounds tied up that may well pay out on your death, which could then become liable for inheritance tax.”
Depending on the terms of the deferred compensation, vesting of your RSUs may be accelerated on your death, so it’s worth thinking about hedging inheritance tax risk with insurance.
It’s not unheard of for executives to receive RSUs for decades as a form of deferred compensation – be that from one company or a number of employers if you move jobs and the RSUs are part of your ongoing reward packages.
The longer you receive RSUs, the more likely they will play a much broader role in your wealth planning across the short, medium and long term; whether that’s for supporting everyday costs, making key purchases, providing for children or investing for the future, including retirement.
“We regularly have conversations with our clients about how much is enough for retirement, what the purpose of their wealth is and what they ultimately want to do with it,” says Ritchie. “While the outcome of RSUs can be uncertain, because of taxation and share price implications, they can still play a pivotal role in your financial decision-making, and getting the most appropriate advice is really important in making your goals a reality.”
Please note: This does not constitute tax or legal advice. Tax treatment depends on the individual circumstances of each client and may be subject to change in the future. You should always check the tax implications with an accountant or tax specialist.
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