Whether you inherited a large holding, exercised options to buy your company’s stock, or sold a private business you might find that a significant portion of your net worth is tied to a single stock. Generally, if an investment accounts for 10% or more of your total portfolio it is considered a concentrated position. While a concentrated stock holding can generate significant wealth, it also poses a tremendous downside risk and presents the need to diversify.
You may be hesitant to mitigate the risk due to a number of different reasons. Some of the most common hurdles are the potential tax implications, emotional factors, and regulatory constraints. However, this is where financial planning can help. A financial plan can show you the impact that price fluctuations could have on your ability to accomplish your short and long-term goals and also help you determine the number of assets needed to achieve your goals. Once you understand the overall impact and determine the risk you are willing to accept, you can then begin to implement techniques to diversify your assets while taking into consideration your potential tax liability.
Concentrated Stock Solutions
Option 1: Sell Your Shares
The most straightforward solution is to sell a portion of your stock outright and reinvest the proceeds in a diversified portfolio. In order to mitigate the tax consequences, you might want to consider strategically selling shares over a number of years rather than in one large sale. This would allow you to minimize and spread the tax over time while still participating in the potential appreciation of the stock. Still, it is worth noting that this could also be a drawback should tax rates rise in the future.
Generally, we recommend selling shares that have been held for longer than one year. In addition, you might be able to sell your shares in conjunction with other strategies, such as tax-loss harvesting, to help minimize your tax liability. However, it will be important to review your personal situation with your CPA and financial advisor to determine the strategy that makes sense for you.
If you hold restricted shares, consider setting up a 10b5-1 trading plan. 10b5-1 trading plans allow executives to sell stock according to a predetermined schedule as long as the plan is adopted when you have no insider information. This tool can be useful if you face limited windows to sell your stock due to corporate trading policies.
Option 2: Donate Stock to a Charity
If you are charitably inclined, a simple strategy is to donate the stock position directly to a charity (or charities). By donating stock instead of cash, you can eliminate the capital gains tax that would have been due if you sold the stock outright and then donated the proceeds, which provides more funds available for giving. In addition, if you itemize your deductions on your tax return, you can still claim a charitable tax deduction equal to the fair market value in the year the gift is made as long as you have owned the shares for more than one year.
Another strategy is to establish a donor-advised fund and donate the stock position to the fund. A donor-advised fund can allow you to eliminate capital gains tax on the sale of the stock, receive an immediate charitable tax deduction and then recommend grants to charities of your choice over time. Donor-advised funds can be a great vehicle to use in a high-income year as they allow you to front load the contributions to maximize your tax deduction but retain the flexibility to decide which charities the funds will go to in the future. Donor-advised funds can also be utilized as a family legacy vehicle by naming your children or other family members as successor advisers and getting them involved in your grant-making decisions.
Lastly, charitable trusts can also be a solution for a concentrated stock position. If you have a concentrated stock position, consider donating it to a charitable remainder trust. Typically, the trust can sell the stock without tax consequences and reinvest the proceeds in a diversified portfolio to provide an income stream for you for a specified number of years. You also receive a tax deduction when you make the contribution. Once the term is over, any remaining assets are then passed to the charity. An alternative is a charitable lead trust which is essentially the opposite of a charitable remainder trust. With a charitable lead trust, the charity takes the lead and receives an income stream for a specified number of years. When the term ends, the remaining assets are then passed to your heirs.
Option 3: Gift Stock to a Family Member or Friend
Currently, you can make an annual gift of up to $15,000 per person (for married couples a combined $30,000) without incurring any gift tax or using part of your lifetime gift and estate tax exemption. If you are gifting shares to family members or friends in lower tax brackets, this can be an effective wealth transfer strategy. Keep in mind that it will be important to consider the basis of the gifted shares to ensure the overall income and estate tax effect are minimized. Gifting assets to heirs could result in a carryover basis which might not be as favorable as the step-up in basis currently received when assets are transferred to heirs upon your passing.
Option 4: Build a Portfolio to Offset Risk
To mitigate the risk of your concentrated position, your advisor can help you build a portfolio around the holding to achieve a portfolio that aligns with your investment strategy. For example, if you have significant exposure to a particular sector (technology, health care, consumer staples, etc.) and market cap segment (small-cap, mid-cap, and large-cap) we can help you construct a portfolio that takes this into account, and helps offset the risk that is embedded in the concentrated stock holding.
A concentrated stock position can help build wealth, but it can also present significant risk. There are a number of ways to reduce the risk of concentrated stock holdings. However, there is no one size fits all answer. Our team of professionals can help you navigate the complexities of concentrated stock positions in conjunction with your financial plan to help you make sound financial decisions and achieve your short and long-term goals.
MEET THE AUTHOR
Senior Financial Planner
Tawny Ramones, CFP®, CPA
Aldrich Wealth LP
Tawny specializes in developing and implementing comprehensive financial plans that provide clients the best opportunity to achieve their cash flow, investment, insurance, and estate planning goals. Prior to her career in financial planning, she concentrated on strategic tax planning and compliance for high-net-worth individuals. Tawny received a Bachelor of Science degree in business administration with…
- Financial planning
- Wealth management
- High-net-worth individuals
- Certified Public Accountant
- CERTIFIED FINANCIAL PLANNER™