Do you have Restricted Stock Units (RSUs) as part of your employment package but are unsure what that actually means and how they work? You're not alone. This is a common dilemma many of our clients face when they first come to us for help.
What are Restricted Stock Units (RSUs)
Restricted Stock Units (RSUs) are a type of compensation offered by employers, typically in the form of company shares given to employees at no initial cost, but with certain conditions attached. These conditions often include a vesting period, during which an employee must remain with the company for a specified time before gaining full ownership of the shares.
RSUs are commonly offered by various companies, ranging from large tech corporations like Google, Amazon, and Facebook, to startups looking to attract and retain talent by offering a stake in the company's future growth. Additionally, companies outside the tech sector, including those in finance, healthcare, and consumer goods, also provide RSUs as part of their compensation packages to align employees' interests with the company's success.
What's a Grant?
When your employer awards you RSUs, it's like they're giving you a "grant." A grant is just a fancy way of saying, "We're promising you something." In this case, what they're promising you are shares of the company itself. But, remember, it's a promise for the future, not something you get right away.
Example of a Grant:
Let's say your company tells you, "We're giving you 1000 RSUs as part of your job here." That means they're promising you 1000 shares of the company.
What's a Vesting Schedule?
The "vesting schedule" is a term for the rules about when you get to claim your RSUs. The company sets up this schedule to reward you for sticking around and contributing to the company's success.
Example of a Vesting Schedule:
Your employer might say, "You'll get 250 of your RSUs each year for the next four years." What this means is, after your first year at the company, you get 250 shares. After the second year, another 250, and so on, until you've received all 1000 shares by the end of the fourth year. It is common if you leave employment for you to lose any RSUs that have not vested. There can different rules for circumstances of retirement or ill health which would be highlighted in your grant agreement.
Each year you stay with your employer, they award you an extra 1,000 RSUs. This leads to a 'cliff vesting', where you can have several batches of RSUs vesting in one tax year, substantially increasing your taxable income for that tax year.
This arrangement not only incentivises long-term commitment to the company but also means strategic financial planning is needed to manage the potential tax implications effectively.
How are my RSUs taxed?
Understanding the taxation of Restricted Stock Units (RSUs) is crucial, as it impacts your financial planning. When your RSUs vest, which means they become fully yours after meeting certain conditions like staying with the company for a predetermined period, they are considered earned income by HMRC.
Taxation at Vesting
The moment your RSUs vest is significant for two reasons: it marks the point at which you gain full ownership of the shares, and it's also when these shares are assessed as earned income. The value of the shares at vesting is treated as additional income, just like your salary, and is taxed at your applicable income tax rate. You are also subject to employee national insurance contributions.
You may also need to pay for employers’ national insurance. Employers can pay this themselves or transfer the liability to you. This is usually facilitated through a "joint election" agreement, where you agree to take on the responsibility for the employer's national insurance liability.
Typically, employers manage the taxation of RSUs through the Pay As You Earn (PAYE) system, similar to how your regular salary is taxed. Since the RSUs are in the form of shares, not cash, most employers adopt a practical approach to handle the income tax and NIC obligations by selling a portion of the vested shares on your behalf.
Capital Gains Tax
When your RSUs vest, if you sell them straight away, you won't be liable for capital gains tax. However, if you hold on to the shares and they increase in value from the date they vest, you may be liable to pay capital gains tax on the proceeds.
Be careful, if you've had multiple RSUs vest over time and kept the shares, working out the gain gets tricky due to varying share values and times. In the UK, you generally average out the cost of these shares into a single "pool." However, there are exceptions, for example if you acquire more shares within 30 days after selling, the new shares are considered sold first.
The capital gains tax (CGT) allowance for the 2023/24 tax year is currently £6,000, however it is to reduce to £3,000 from the 2024/25 tax year. Any growth in the value of the shares from the date of vesting, over the CGT allowance will be subject to tax at 10% for basic rate tax payers and 20% for higher and additional rate taxpayers.
If you have a spouse, it is possible to transfer the shares to them where you can use both your capital gains tax allowances, thanks to the inter-spousal transfer exemption.
Holding shares in the company you work for means you're really backing your employer. Think about it like this: if you got a cash bonus, would you buy more of the company shares with it? If you're leaning towards "no," then selling your shares to invest elsewhere might be a smart move. This way, you're not just relying on how well your employer does.
Case Study: Alex's Strategic Pension Contribution
Meet Alex, a software engineer with a passion for coding and a loving parent to two young children. Alex's compensation includes a salary of £100,000, and this year, £50,000 worth of RSUs are due to vest. With a growing family, childcare is a significant expense at £20,000 a year, and Alex has been keen on using tax-free childcare to ease this burden. However, there's a catch: due to Alex RSU vesting they will now earn over £100,000 for the tax year which means losing eligibility for this benefit. Let's see how a well-timed pension contribution not only brings tax relief but also reopens the door to tax-free childcare savings.
Before Making a Pension Contribution
Initially, Alex's total income, combining their salary and vesting RSUs, shoots up to £150,000. At this level, not only does Alex face a higher tax rate, but they will also lose their personal allowance and the option to use tax-free childcare, which could have saved them 20% on childcare costs.
Because the RSUs push Alex's total income above £100,000, he will pay 60% income tax on the RSUs.
This is known as the 60% tax trap. For every £2 you earn above £100,000, your Personal Allowance is reduced by £1. This means that in addition to paying the normal 40% tax, he will also pay an additional 20% tax on income that was previously tax-free, resulting in a total tax rate of 60%
The Power of Pension Contributions
Alex decides to contribute £50,000 gross contribution into their pension. This move is not just about saving for the future; it's a strategic decision with immediate financial benefits:
Reduces net Adjusted Income: The pension contribution lowers Alex's total income to £100,000, keeping it at the crucial £100,000 threshold.
Preserves Personal Allowance: With an adjusted income of £100,000, Alex fully retains their £12,570 personal allowance.
Reinstates Tax-Free Childcare: By keeping their income at £100,000, Alex remains eligible for tax-free childcare, significantly reducing childcare costs by £4,000 a year.
The Double Win
Alex's decision to make a substantial pension contribution turned out to be a double win: not only did they save significantly on taxes by preserving their personal allowance, but they also regained access to tax-free childcare. This move not only supports Alex's immediate financial health by reducing childcare costs and tax liabilities but also contributes to their long-term financial security through increased pension savings.
How we can help at Pura Vida Financial Planning
Feeling confused by RSUs? We're here to simplify things for you. At Pura Vida Financial Planning, we offer clear advice tailored to your unique needs. Whether it’s making sense of RSUs or planning for your family's future, we’re here to guide you.
Why not take us up on a free, friendly chat with no obligations? It’s a chance for you to see how Pura Vida Financial Planning can help you tailor a financial plan that fits you perfectly, no matter what life throws at you.
This article is for informational purposes only and is not intended as personal investment advice. If you’re not sure what is right for you, we strongly recommend seeking professional advice.
HM Revenue and Customs practice and the law relating to taxation are complex and subject to individual circumstances and changes which cannot be foreseen. Tax concessions are not guaranteed and may change in the future.
Remember that investments can go up and down in value, you may get back less than you put in.
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