The S&P 500 was down about 2% last week, but the devil is in the details. Remember that the index is cap-weighted, meaning the bigger a company is, the higher percentage of the index it represents. The tech sector had a large sell-off, while other stocks gained. If you weighed all 500 companies equally, the S&P 500 was positive. In fact, 70% of the stocks had a positive week.
Market performance can also have an impact on anyone who receives equity compensation as part of their pay. This can include stock options, or more commonly, RSUs, or Restricted Stock Units. There are several good reasons why companies like to pay with equity. First, it doesn’t impact cash flow. It will still be reported on financial statements, but the company isn’t spending cash to pay that portion of your salary. Next, it provides an incentive for employees to stay with the company. RSUs are usually granted annually, but vest over three to four years. If you leave the company, the RSUs that have not vested are lost. Finally, it encourages employee productivity, because they own stock in the company.
Restricted Stock Units can vest several different ways. Let’s imagine you just started at Spacely Sprockets and received 500 RSUs. They vest quarterly over five years, with a one-year cliff. For the first year, you receive nothing. At the end of the first year, your first 100 RSUs vest, meaning you now own 100 shares of Spacely Sprockets. Every three months after that for four years, 25 RSUs vest.
When you receive the RSU grant, you do not have any income, as the RSUs aren’t worth anything until they vest. Continuing our example, when the first 100 RSUs vest, you have income of 100 times the current share price of Spacely Sprockets. The IRS doesn’t care if you are paid in cash, stock, or toasters. The IRS considers the value of what you received to be income. If you are paid in cash, a percentage is withheld for taxes. But you can’t send the IRS shares of stock. Your company will usually sell to cover, meaning they will sell the same percentage of stock as they usually withhold from cash payments, then submit that cash as withholding.
It’s important to look at how your company does that. If you are in a top tax bracket, their default sell to cover percentage may not be enough, and you will have a large tax bill in April. If it’s a privately held company, or you believe the company is about to have a major breakthrough and you want to maximize your ownership stake, you may consider increasing cash withholding, and asking your company not to sell to cover, so that you retain more shares.
When the RSUs vest, and after your company sells enough to cover the tax withholding, your stock will be transferred to an investment account. You have several options. You can just leave the stock as-is. We generally recommend limiting your employer’s stock to no more than 10% of your total net worth. If you sell this stock in the future, you will pay capital gains on the amount the stock increased since you received it.
You can also sell the stock. There will not be any additional tax, as the full amount you received was already included in your income. You may want to diversify your portfolio and reduce the risk that comes with a concentrated stock position.
Finally, you can usually transfer the stock to your current advisor. This allows the stock to be incorporated into your overall portfolio. Your advisor can also establish a securities-backed line of credit against the stock if you plan to hold on to it. This line of credit is similar to a home-equity line of credit, just against your investments instead of your home.
If you have RSUs, it’s important to discuss your strategy for handling them with your advisor and tax professional.
Your action item this week is to freeze your credit. Contact the three credit bureaus to prevent someone from opening accounts in your name.
If you have a question you want answered, email us at info@covingtonalsina.com. Be sure to check out our Facebook page or website to see our upcoming educational events.
CovingtonAlsina is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.