How To Defer and Diversify RSUs

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To further enhance your knowledge about RSUs and their rise to prominence over Stock Options, we’ve made it easy to read our four-part series “Add Flexibility and Value to Long-Term Incentive Plans Through Deferral and Diversification of RSUs”.

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Deferring RSUs – How You Can Regain Control Over Their Taxation

Evolution of Stock Compensation Plan Design

  • Stock compensation often represents the largest part of the total rewards package for senior executives of publicly traded companies.
  • Stock options used to be the primary form of equity grants, but restricted stock or restricted stock units now account for the largest share of equity awards.1
  • A “portfolio” approach is commonly used, which typically includes both time-vested Restricted Stock Units and performance-based RSUs.

Loss over Control of the Timing of Taxation

  • With the switch from stock options to restricted stock has come an executive’s loss over the control of the timing of taxation.
  • With stock options, executives typically had a ten-year timeframe for executing options. Executing the options triggered taxation, a decision controlled by the executive.
  • With restricted stock units, taxation is triggered by vesting. Vesting is typically time-based, often pro rata over a 3-to-4-year period.  Time controls taxation, not the Executive.

Regaining Control over the Timing of Taxation

  • Executives can regain control over the timing of taxation if the Company offers a Deferred Compensation Plan.

Coordination of the RSU plan with a non-qualified deferred compensation plan could provide significant financial planning flexibility:

  • Deferral of federal income taxes upon vesting,
  • A possible reduction of state income taxes and,
  • Flexible management of distributions.

Advantage of Tax Deferral Upon Vesting Of RSUs

What’s the financial advantage of deferring RSUs? 

  • If deferred, the executive doesn’t have to sell 40% to 50% of the shares upon vesting to pay taxes.
    • 100% of the RSUs continue to appreciate, rather than 50% or 60%
    • Dividends, if paid, are received on 100% of the RSUs rather than on 50% or 60%

As a hypothetical example, if a 50-year-old elects to defer RSUs worth $250,000 at the time of grant, to retirement at age 65

  • The RSU holdings in the Deferred Compensation Plan at retirement could be worth $368,000 more than the holdings without deferral
  • If the executive elected a 10- year installment payout, the after-tax income realized from deferral could be 32% higher annually.

Diversification of RSUs Deferred

  • One concern among executives about the deferral of RSUs is a concentration of net worth tied to company share value.
    • They would prefer to diversify as they might if they received the shares, paid taxes upon vesting, and then reinvested in a diversified portfolio.
  • A plan can be designed, under certain conditions, to allow participants to sell deferred RSUs without triggering tax and reallocate the proceeds to other investment options available in the plan.

Considerations and Risk of Deferring RSUs

  • Subject to market fluctuations of the company’s underlying stock and/or diversified investment choices

Exploration of the Deferral and Diversification Concept

If you have an interest in learning more about deferring RSUs, we welcome an opportunity to speak with you.

For further insight, our Resource page has two informative RSU case studies:

Disclosure:

The financial projection comparing the benefit of deferring RSUs with a value of $250,000 was based on the following assumptions:

  • Executive age 50 defers for 15 years, then distributions over 10 years
  • Personal income tax rate of 40%
  • Payroll Taxes equal to 2.35%
  • Stock price grows 6% per year, 3% dividend
  • Investment account earns 6%, 25% blended tax rate on investment income

1 Source:  2018 Radford Long-Term Incentive Practices Report for Technology Companies

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