Some of our clients own, or have exposure to, very large single stock positions. For these clients, we ask the following questions:
- If this single stock falls dramatically in value, how will the loss affect your financial condition?
- How will you feel if this happens?
Most of the time, the financial loss would make a significant difference to our client's financial plans. We then ask why the stock hasn't been sold and their answers often reveal an emotional attachment to the stock. Maybe it was inherited or the client was an executive at the company; perhaps the client is hesitant to sell the stock because the stock has very low basis and the capital gains are significant—incurring a large capital gains tax.
Concentrated stock exposure, especially if it represents a large percentage of net worth, is a problem when a significant loss of value would negatively affect your financial plans. Doing nothing is an option, but most clients are conflicted with concerns about the stock's volatility and their hesitation to sell or reduce their exposure to the stock. The primary goal of diversifying is to reduce risk and invest in a more appropriate portfolio of securities. Below are six options that we discuss with our clients:
- Sell the security outright, recognize all the gains in one fell swoop, pay the capital gains tax and then redeploy the proceeds into a more appropriately diversified portfolio.The problem with this strategy is that it may not be the most tax-effective approach.
- Slowly diversify by establishing a timeline that spreads sales of the stock over 2, 3 or 5 tax years.This approach may be more tax-efficient because capital gains are spread out over multiple tax years.It also keeps you partially invested in the stock in case you are bullish on the specific stock.
- Time sales of the highly-appreciated stock to correspond with capital losses, which can be used to offset the capital gains. This strategy may take longer to fully diversify the holding, but it may meet the client's goal.
- Time sales of the stock during years of very low income to manage the capital gains tax.Federal capital gains tax rates can range from zero to 20%, depending upon the client's taxable income. Clients need to consider the 3.8% tax on Net Investment Income and state income taxes as well. Some clients will consider gifting the stock to their low-income adult children or grandchildren and have the children pay the tax at the lowest possible tax-bracket.
- For clients who are charitably inclined, consider utilizing charitable gifting strategies to manage taxes and efficiently reduce exposure to the concentrated stock, especially during years of high income.Gift a stock directly to a charity or via a donor-advised fund. If you want to benefit charity and retain an income stream, consider a Charitable Remainder Trust or a Charitable Gift Annuity.
- Great wealth can be achieved if someone owns the right stock for the right period of time, but these tremendous gains can disappear very quickly. Even if you are hesitant to pay capital gains taxes or you believe the stock will continue to increase in value, once you have reached your financial objectives, consider reducing your exposure and risk.
Please call us at 617-728-7433 if you would like to review any of these risk reduction strategies and see how they can fit into your overall financial planning.
Peter Raskin is a registered representative of Lincoln Financial Advisors Corp. Securities offered through Lincoln Financial Advisors Corp., a broker-dealer (SIPC). Investment advisory services offered through Sagemark Consulting, a division of Lincoln Financial Advisors Corp., a registered investment advisor. Insurance offered through Lincoln affiliates and other fine companies. 125 Summer Street, Suite 1400, Boston, MA 02110 617.728.7444 Lincoln Financial Advisors Corp does not provide legal or tax advice. CRN-1023194-092914