Understanding RSUs: A Beginner’s Guide to Restricted Stock

Restricted Stock Units (RSUs) represent a form of equity compensation offered to employees, where the employer promises to provide shares in the company at a future date. RSUs are commonly used as part of compensation packages at major technology firms such as Microsoft, Amazon, Intel, and Google.

Over time, RSUs can become a substantial portion of your income and net worth, making it essential to understand their mechanics, taxation, and the best strategies for managing them.

How Do RSUs Function?

RSUs are typically granted during key milestones in an employee’s career. For example, large technology companies like Microsoft and Google often provide RSUs to new employees as part of their compensation package. Additionally, RSUs may be awarded annually or based on the company’s performance. While RSUs share similarities with Company Share Schemes, they operate differently.

There are two important dates to consider with RSUs: the grant date and the vesting date. The grant date is when the RSU is initially awarded, and the vesting date is when the RSU becomes available for sale. Usually, RSUs vest incrementally rather than all at once.

For instance, if you begin working at Microsoft in January 2021 and are granted 100 RSUs with a four-year vesting schedule, 25% of the RSUs will vest each year. This means that 25 shares will become available after the first year, another 25 after the second year, and so forth. If you continue working at the company, you might receive an additional 100 RSUs each year, leading to a scenario where multiple vesting periods occur annually.

How Are RSUs Taxed?

RSUs are not taxed at the time they are granted. Instead, taxes are due when they vest. In the UK, the tax treatment of RSUs is similar to how salary is taxed. Upon vesting, you’ll owe income tax and employee National Insurance contributions, and possibly employer National Insurance as well. Whether the employer pays this or passes it on to you can vary.

If you are responsible for the employer’s National Insurance, you need to deduct this amount from the RSU’s value before calculating your income tax. However, this deduction does not apply when calculating employee National Insurance.

For example, if you earn a salary of £150,000, receive RSUs worth £50,000, and are liable for employer National Insurance, after taxes, you might end up with £22,705 from the RSUs, despite their £50,000 value.

Typically, the tax is withheld before you receive the shares, so you’ll get the net amount after taxes have been deducted.

How Can I Reduce Tax on RSUs?

One method to reduce the tax burden on RSUs is by making pension contributions. Contributing to a pension lowers your ‘adjusted net income,’ potentially reducing your tax rate and overall tax bill.

For example, if you earn £100,000 and receive RSUs worth £25,000, your total income would be £125,000, pushing you into the 60% tax trap. By contributing £25,000 to a pension, your taxable income would decrease to £100,000, helping you avoid paying tax at 60%

Do I Pay Capital Gains Tax on RSUs?

Once your RSUs vest, you can sell the shares immediately without incurring additional taxes. However, if you hold onto the shares and their value increases, you might be liable for capital gains tax on the profit.

Each individual has an annual capital gains tax allowance, which was £12,300 until the 2022/23 tax year. From 2023/24, this allowance was reduced to £6,000 and is now £3,000 in 2024/25. If your gains exceed this allowance, you’ll pay capital gains tax at 20% if you’re a higher-rate taxpayer (or 10% for basic-rate taxpayers).

How Can I Minimize Capital Gains Tax on RSUs?

There are two main strategies to minimize capital gains tax:

• Sell the Shares Immediately Upon Vesting: This strategy avoids capital gains tax by ensuring there is no gain to be taxed. If you wish to retain the shares, consider repurchasing them within a Stocks and Shares ISA, where future growth is tax-free. Alternatively, holding the shares in a pension ensures tax-free growth, and no withholding tax applies if the pension is set up correctly.
• Transfer RSUs to Your Spouse: If your RSUs have appreciated significantly, transferring some shares to your spouse can be beneficial. Thanks to the inter-spousal transfer exemption, this transfer is tax-free, allowing your spouse to sell the shares using their own capital gains tax allowance. This strategy effectively doubles the amount of shares you can sell before incurring capital gains tax.

What Should I Do with My RSUs?

For most individuals, the best approach is to sell RSUs immediately after they vest. This strategy not only avoids a future capital gains tax liability but also mitigates risk. By holding company shares, you are effectively increasing your financial exposure to your employer. If you wouldn’t reinvest a cash bonus in company stock, you might want to sell your RSUs and diversify your investments.

If you want some help or have other questions, then why not reach out to us using our contact form below or take a look at our accounting partner, ESDG Accountancy, for a RSU Tax Calculator.