Stock based compensation has become increasingly popular because of the advantages to both the companies and the employees. However, many highly compensated individuals find themselves in a situation where they are wealthy on paper – yet unable to protect that wealth. Investors who have spent their lives building their careers at a single company may not fully understand the risk of holding a concentrated position.
In fact, 69% of all U.S. stocks experience a catastrophic loss – a price decrease of over 70% – over their lifetime, and 57% of these never recover their value (Eaton Vance, Concentrated Stock Positions). That’s why at FCA Corp we help clients to diversify concentrated stock positions when appropriate – always with their unique financial goals in mind.
Large tax liabilities, liquidation restrictions and even emotional attachment can lead to a portfolio that’s far more concentrated than is appropriate given a client’s risk tolerance. So, what can you do to make the most of what you’ve earned? Well, there are several possible tactics, but the right one depends on your unique situation and a deep understanding of your financial goals. At FCA Corp, we work with executives seeking to reduce taxes, increase cash flow, and increase their inheritable estate. Each path requires thoughtful individualized planning.
Diversify When You Can
Even sophisticated investors often make the mistake of viewing their brokerage account, IRA, 401(k), and defined contribution pension plans as separate portfolios, rather than recognizing that they are all part of a larger, unified investment strategy. A concentrated position in one account can be offset by low correlation investments in another. Be sure to take full advantage of any company plans that offer the diversification you’re seeking.
Be aware of the top holdings in any mutual fund or ETF you own. For example, if you are holding a concentrated position in a single stock then holding an index fund in your retirement portfolio may not provide the diversification you’re aiming for.
Tax-Smart Strategies
Set an annual acceptable capital gains budget. By identifying specific lots and selling a portion of the concentrated position each year, you can control tax recognition and manage resulting gains or losses. Careful planning, in coordination with your financial advisor and tax preparer, is key to making this strategy as effective as possible.
Use tax loss harvesting to your advantage. In a diversified portfolio some of your positions could lose value, even in bull markets. Instead of thinking of these as an equity loss, consider them as a “tax asset” to offset your tax liability. Consult with your financial advisor so not to fall afoul of the wash sale rules.
When it comes to charitable contributions, donating appreciated stock can be more tax advantageous than donating cash. The full value of the donation may be deductible (depending on the amount of the donation and your MAGI) and capital gains on appreciated stock may not need to be realized. In a high income year, consider donating several years’ worth of regular charitable contributions to get the maximum tax benefit from your donations. A charitable gift fund can simplify this process.
Advanced Planning Strategies
Options can be a useful tool to help diversify a concentrated stock position by managing risk and may also provide opportunities to generate additional income. For example, a protective put strategy may help limit downside risk, while a covered call strategy can potentially generate additional income and reduce overall portfolio risk.
These strategies can have a significant impact on your portfolio’s risk tolerance and can help diversify a concentrated stock position. Options should only be used in close consultation with a financial professional experienced with these advanced investment tools.
Trust and Estate Planning
Transferring highly appreciated stock to a charitable remainder trust (CRT) can be beneficial due to the upfront tax deduction. Since the CRT is a tax-exempt entity, it can sell the donated stock without realizing capital gains, while also providing the grantor with lifetime income.
Alternatively, a concentrated position may be held for life, allowing your heirs to receive a step-up in the basis of the stock. In many circumstances, the entire position can be transferred to your heirs without realizing capital gains.
Proper estate planning and use of trusts can ensure your heirs receive the maximum amount possible, while also fulfilling your estate wishes. Coordination with your financial advisor, tax planner and estate planning attorney is crucial to ensure that these techniques are implemented correctly.
Contact FCA Corp Today
At FCA Corp, we work closely with executives to help them navigate the complexities of concentrated stock positions. Our team of attorneys, CPAs and CFP®s takes the time to understand your unique circumstances and works with you to develop a thoughtful, diversified strategy as part of a comprehensive financial plan. Contact us today to get started on a customized plan that aligns with your long-term goals.
