Recently we have seen an uptick in enquiries about the pros and cons of being awarded Restricted Stock Units (RSUs), and ways in which clients could save the potentially high rates of tax.
RSUs form a part of an individual’s income and tax rules are applied similarly to salary and bonuses. Therefore, although my thoughts here are focused on RSU awards, the same broad methods for reclaiming any overpaid tax can be transferred to offsetting income taxation from salary and bonus.
RSUs: An Introduction
At its simplest, RSUs are awards of shares in the company an individual works for and can become a significant part their overall income. They are usually awarded at certain events, such as when someone is hired or as part of performance reviews. However, the shares are not immediately made available to sell.
The date they become available to sell is known as the “vest date”, a predetermined date at some point in the future. Usually, there is not one single vest date, and instead the share award is staggered over a number of periods. It’s worth noting that on the vest date, income tax is paid regardless of whether you keep or sell the shares.
The use of Restricted Stock Unit (RSU) awards has increased in the UK over the past decade, primarily because more US tech companies, such as Amazon, Apple Facebook, Google and Microsoft have entered the UK employer market and favour adding RSUs to an individual’s overall compensation package.
For example, Laura joined a tech company in January 2019 and was awarded 500 shares which, after an initial year would vest quarterly. The first vest date of these shares is January 2020, when 50 shares vest. A further 50 shares then vest every quarter until a total of 500 shares have vested, the final shares becoming available in April 2022. Therefore, to receive her full quota of RSUs Laura would need to remain with the company throughout January 2019 to April 2022.
The Problem
When shares are awarded there will not be any tax to pay. However, income tax is payable on the date the shares vest, and this tax will likely be more complex and higher than previously considered.
Complexity – the shares will usually vest net of tax, with the total amount of shares received and tax paid being based on the share price that day. The tax is paid at source via a cancellation of shares, equivalent to the amount of tax due. There will likely not be a breakdown provided of how the tax is calculated, leading many people to assume no tax is paid as they never saw the original amount of shares received.
Higher Taxation – As stated above, RSUs are a taxable benefit and are usually taxed in a more punitive way than normal salary and bonus. Income tax and employee National Insurance is paid at the marginal rate via a cancellation of shares. However, they will also be received net of employer national insurance, which in 2021/22 is 13.8%.
Assume Laura earns a salary of £100,000 and also receives RSUs valued at £20,000 in the 2021/22 tax year.
| RSU vested in 2021/22 tax year | £20,000 |
| Less Employer National Insurance (13.8%) | -£2,760 |
| Net RSU Value Before Employer Income Tax/ NI | £17,240 |
| Less 60% Income Tax (40% Higher Rate Tax plus Loss of Personal Allowance) | -£10,344 |
| Less National Insurance (2%) | -£345 |
| Residual Value After All Tax | £6,551 |
| Effective Tax Rate | 67% |
To summarise, in the situation above Laura receives £20,000 worth of shares which, after tax amount to only £6,551. Thereason for the higher taxation is that employer National Insurance is taken from the gross amount of shares received, whereas when considering salary or bonus, employer national insurance is paid separately. Moreover, the personal allowance is lost by £1 for every £2 of income over £100,000, increasing the higher rate of tax from 40% to 60%.
The Solution
There are ways in which the tax can be minimised. Once the shares are received and if Laura were able to utilise funds from cash or excess income, she could make a gross contribution of £20,000 to her pension. Net, this would only require a £16,000 contribution, as any qualifying personal pension contribution will receive basic rate tax relief of 20%, or in this case the contribution will be ‘topped up’ by £4,000 to £20,000. This would reduce her income back to £100,000 and would fully reinstate her personal allowance.
Using the example above, let’s see the difference in net returns when a £20,000 gross pension contribution is made:
| RSU vested in 2021/22 tax year | £20,000 |
| Less Employer National Insurance (13.8%) | -£2,760 |
| Net RSU Value Before Employer Income Tax/ NI | £17,240 |
| Less 40% Income Tax (40% Higher Rate Tax, no lost personal allowance) | -£6,896 |
| Less National Insurance (2%) | -£345 |
| Residual Value After All Tax | £9,999 |
| Effective Tax Rate | 50% |
| Plus Basic Rate% tax relief on pension contribution | £4,000 |
| Plus Higher Rate Tax Relief on pension contribution to be claimed via self-assessment | £4,000 |
| Effective tax rate after all reliefs claimed | 10% |
The Benefits
Not only would Laura benefit from reclaiming her personal allowance which was lost on receipt of the shares, but she would also receive both basic rate tax relief on the pension contribution and could claim additional higher rate tax relief via self-assessment. The effective tax rate drops from 67% in the first example, to 50% immediately after the contribution and 10% after all reliefs are considered, which represents an 85% reduction in taxation from the first example.
The funds, which are now within Laura’s pension, can build up her retirement savings and will benefit from tax free growth. Up to 25% of her total pension can be drawn tax free, currently from age 55 but this is increasing to age 57.
Alternatively, if Laura had either maximised her ISA and pension contributions for the year or exceeded her pension lifetime allowance, she might consider alternative methods of tax relief, such as Venture Capital Trust (VCT) investments. Although usually invested in more volatile areas and not carrying the same level of tax relief as pensions do, VCTs would offer tax relief of 30% on any investment and could be put towards reducing the tax overpaid on receipt of the shares.
To sell or not to sell
Finally, it’s worth touching on whether or not you should sell an RSU if received. As we note above, you pay tax when the shares vest, even if you have no intention to sell the share. However, if you do retain the shares outside of an ISA portfolio then any gains do have the potential for further tax under the capital gains tax (CGT) regime. Moreover, by retaining the shares, the money will only be invested in one company. By selling the shares immediately and reinvesting the proceeds into an ISA or SIPP, you will have the potential to diversify into various shares or investments funds which are spread across asset classes, geographic areas and sectors.
How can Tideway help?
Tideway Wealth are specialists in tax efficient retirement planning. We work with our clients to understand their income, assets and potential opportunities to benefit from tax relief. We can work with you to decide the best solution for managing your RSUs and how they can benefit you in the long term.
The content of this document is for information purposes only and should and should not be construed as financial advice
Please be aware that the value of investments, and the income you may receive from them, cannot be guaranteed and may fall as well as rise.
The information contained in this document related to tax are correct at the time of issue; however, tax legislation and the levels of relief are subject to change at any time.
We always recommend that you seek professional regulated financial advice before investing.
