Jonny's Promotion

TL;DR:

• The pay raise trap: As you climb the corporate ladder, a massive hike in total compensation often translates to a surprisingly small increase in bi-weekly net pay.
• RSUs are not liquid: Your stock grants are "promises" that follow a multi-year vesting schedule. Be careful how you plan your finances.
• Patience pays off: While the first year feels underwhelming, the compounding effect of vesting RSUs creates a significant ramp-up in total net income over time.

Jonny Got a Promotion

Jonny was really excited when his boss told him about the promotion. That night he couldn't sleep. 

His mind kept doing paycheck math. “Starting next month I will make $200k, a $50k raise. I will not get all that money, but I will be making 33% more. The math is simple. My last paycheck was about $3,900, a third is $1,300. Thirteen hundred extra bucks every 2 weeks! What am I going to do with all that extra money? Maybe I should lease that Corvette that I have been dreaming about.”

Jonny had good reasons to be happy, but he was also about to suffer two disappointments that many young engineers suffer when they start making “serious” money.

The First Disappointment 

The next payday arrived. “What? $263? There must be a mistake. I will  talk to the HR person.”

“Jonny, everything looks right. See, your base salary went up by $10k, the other $40k increase is bonus and RSU, that will be granted in a year.”

Jonny felt scammed. However, after reading online forums, watching videos, and talking to friends, he finally accepted the fact that as you rise through the ranks, an increasingly large portion of your compensation is variable, and you don't see it in your regular paychecks.

“Well, I will still get my money, just a little later. I should have waited a bit before leasing this car, but I will be okay.”

Little did Jonny know there was another unpleasant surprise for him in store.

The Second Disappointment

Jonny worked hard all year. “I better secure this ‘variable’ compensation”, he kept thinking. It was tough, the new role brought increased responsibilities, but he rose to the challenges.

“You did well this year”, said the manager during the compensation discussion. “We are all happy with your performance. You will be granted 100% of your target cash bonus and RSU. Congratulations!”

“Yes! $60k in bonus and RSUs!” Jonny thought. “I will pay off my debts and still have plenty left to indulge myself. I will sell all the RSUs as soon as I get them. This $60k is going to be at least $45k after taxes, probably more, I don't pay 25% in taxes. Let me check my last tax returns.”

A few days later. “Where is the option to sell the RSUs? Do they really need to make it so hard? I will need to get some help.”

“Oh Jonny, you can't sell your RSUs until they vest.” 

“Vest? What is that? When do they vest?” 

“The RSUs vest on a 3-year schedule, 33% each year, meaning you can only sell that portion at a time.”

“So, I can only sell a third of my RSUs now?”

“No, Jonny, you can’t sell anything until a year from now.”

That felt like a cold shower.

The Basics of Total Compensation 

Don't feel sorry for Jonny. He will do pretty well in the long run, but he could have learned a few lessons before his big promotion to make better financial decisions and have more realistic expectations. These lessons are better learned when the emotions are out of the way and the stakes are low.

Let's start with total compensation. Most tech companies break it down into three main components:

• Base salary: A fixed amount not tied to performance. This is the gross income in your regular paychecks. In general, junior levels receive a higher percentage (or all) of their total compensation as base salary compared to senior levels.
• Cash bonus: What most people think about when they hear the word bonus. It is a cash payment granted once or twice a year. The amount depends on the target defined in the compensation package, the company performance, individual performance, and in many cases, the performance of the team, group, division, etc.
• RSU: Restricted Stock Units, or RSUs, are promises of future shares granted based on similar criteria as the cash bonus. 

Let’s deep dive into RSUs. The key words are “promises” and “future”. The company is promising a number of shares based on current share price. Let’s say the price is $100. With a grant of $30,000 in RSUs the company is promising 300 shares for a future date. To be more precise, it is generally 3 or 4 future dates. This is known as the vesting schedule. In Jonny's example, the schedule is 3 years with a third of the shares vesting each year. If he was granted 300 RSUs, he would get 100 shares each year for the next three years. 

Note that the promise is the number of shares, not their value. Nothing guarantees they will be worth $100 each by the time they vest. For healthy companies in a healthy economy, the share price goes up, but sometimes the price goes down. In fact, he will get nothing from the outstanding RSUs if either the company goes bankrupt, or he leaves it.

A Closer Look at Jonny's Numbers

Now that we understand total compensation, let's look closer at Jonny's numbers. We will estimate his taxes using 2025 tax brackets. To make the math simple, we will assume he is single, doesn't own any real estate, doesn't have any source of income other than his salary, and doesn't have any pre-tax deductions.

Note that the base salary increased only 7.69% even though the total compensation increased 33.33%. This is normal as you move up the corporate ladder. Additionally, the bi-weekly net pay increased only 6.85%. The reason it increased less than the base salary is taxes. To put it simply, each additional dollar you make is taxed at a higher rate than your average dollar. The details are out of the scope of this post, but you can find plenty of information about tax brackets and marginal tax rate on the internet.

Now let's talk about one year after Jonny’s second disappointment. It is impossible to predict what the stock price will be in the future. A simple rule of thumb is to assume it will not change. A better approach is to assume a max and min value and plan for each scenario. 

As you can see in the following table, based on the assumption that the stock will be worth between -50% and +50% of today's value, Jonny's total net pay will be somewhere between $129,711 and $136,546.

So far, the promotion doesn't seem like a big deal. However, thanks to the compounding effect of RSUs over time, Jonny’s total net pay will keep growing for 3 years even without any salary increase or new promotion.

The following table shows what the total gross pay and total net pay will be each year assuming no change in the stock price and no change in total compensation.

Finally, the following cone of uncertainty shows the range of probable total net pay each year based on -50% to +50% stock variation range and no change in total compensation.

I personally like Jonny's odds, don't you?

Final Thoughts

Here we covered some basics about financial literacy that each software engineer should know. But this is not all. There are many other factors that impact your net pay and net worth, and you should get familiar with them. For example: discounted stock, 401k match, wellness incentives, HSA employer contribution, tax brackets, pre-tax deductions, tax rules on different types of investments, among others.

For now, I will close by telling you two things. When it comes to money, learn the rules of the game and play it accordingly. When you get that desired promotion, celebrate, look at the big picture, and know that the big game just started.