Intel, a major electronics manufacturer, is one of many American companies that issues RSUs as a form of incentive compensation to its employees. The expectation is that the employees will be motivated to help the company meets its growth objectives. The hope is that the company’s stock price will increase and both the company and the employee benefit.
Intel typically grants RSUs after an employee’s annual performance review. RSUs vest over a predetermined period. (Typically, three years in the case of Intel.) If, for example, an Intel employee received 300 RSUs, those units would vest in 100 increments over three years.
When an RSU vests, it is considered compensation and taxed as ordinary income. As an example, let’s assume that Intel stock is currently trading at $35 per share. At that price, 100 vested RSUs would represent $3,500 of taxable income. The employer will withhold estimated taxes – federal, state, Social Security and Medicare – by not distributing all of the vested shares. If we assume the total taxes are 25%, then $875 (25% x $3,500) would be withheld. This translates into 25 shares ($875/$35). So, the employee would actually receive 75 (100 – 25) shares. If the employee were to immediately sell those remaining shares, she would receive $2,625 (75 x $35, net of all taxes withheld).
One of the challenges associated with receiving employer stock as compensation is that the employee will often end up with a portfolio that is over-concentrated in employer stock. Sound investing requires diversification across and within asset classes. A portfolio which is overweight in a certain stock (e.g. Intel) and thus a certain asset class (e.g. US large cap value stocks) has an inferior risk/return profile compared to a portfolio that is properly diversified.
So, employees who receive employer stock should have a strategy to periodically sell vested shares and reinvest the proceeds in other investments, to maintain a diversified portfolio. This is often hard for employees, because of their loyalty to their employer, their reluctance to pay taxes upon the sale of the stock and inertia.