One of the greatest benefits of working your way to becoming a C-suite-level employee is receiving equity compensation, whether it be in the form of qualified or non-qualified stock options, or restricted stock units. There is really no greater way for an employer to ensure that its top employees are vested in the future growth and prosperity of the company than by offering these benefits. Likewise, there is no greater feeling for an employee than implementing a new strategy or idea, seeing that come to fruition, and being compensated in the form of equity compensation through the rise of the company stock market price.
The downside of equity compensation is that your financial portfolio can easily and quickly become concentrated with your employer’s stock. In most cases, there is no real way to completely avoid accumulating a concentrated and highly appreciated stock position when you work for a growing company. Due to the rise in stock price and your lower cost of purchase, you can quickly be looking at a large capital gains tax bill if and when you choose to sell your stock. There are, however, multiple strategies that you can help to diversify your concentrated position and offset the tax burden associated with the highly appreciated stock. Two of those strategies include exchange funds and an index proxy.
Discuss your equity compensation plan with the Carpenter Team during a complimentary consultation.
Effective Strategies for Highly Appreciated Stock in Concentrated Portfolios
Exchange Fund
This is a strategy that we find many top-level executives aren’t even aware of, even though it has been around for years, and it’s truly an effective way for you to diversify a highly appreciated and concentrated stock position.
In short, an exchange fund is structured in a way that allows it to accept a large concentrated stock position in exchange for shares of the fund itself. Multiple investors bring their concentrated positions to the fund in exchange for shares, which is a way for the group to spread risk over a number of equity holdings.
One aspect of exchange funds many people don’t realize is that if the fund has at least 20% of its value composed of non-publicly traded assets, the investors are allowed to defer capital gains taxation when they enter the fund. It is important to note that the investor will still owe capital gains tax on the gains when they sell their shares of the exchange fund, factored by using the cost basis of each original equity holding of all the investors.
This is a great strategy to use if you are attempting to diversify your equity holdings as well as defer the capital gains tax due on your highly appreciated stock. This strategy is best when implemented with the help of a seasoned financial advisor who has experience with exchange funds and focuses on equity compensation planning.
Index Proxy Strategy
Another strategy that can help you diversify your concentrated stock position is known as an index proxy strategy. One of the major benefits of this strategy is that you, along with the help of a trusted advisor, can build in the taxable guidelines you would like to follow as you begin to sell your equity.
For example, if your goal is to minimize the amount of capital gains tax owed in a given year, you can set your strategy to limit sales of highly appreciated stock to a certain maximum amount. This ability makes it one of the best quantitative strategies to handle a highly appreciated stock position.
The index proxy strategy is implemented through unique software that will systematically sell your stock to reduce your concentrated stock exposure. As you sell your concentrated stock, the index proxy software will automatically diversify your portfolio by purchasing other equities or financial holdings of your choosing. The flexibility this strategy gives you is tremendous when dealing with an appreciated stock position. In fact, you can even set up your strategy to harvest losses at certain points to help offset your capital gains taxation.
The strategy itself is truly customizable, but the main goal is to systematically reduce your concentrated position while taking into account the taxable burdens caused by those sales. For this reason, you can work with your advisor to develop a timeline over which you would implement this strategy. If your equity holding continues to go up in value, you might want to spread your sell-off strategy over a number of years so you don’t incur too large of a tax bill. The downside to a long sell-off is that it retains your concentrated stock risk longer as well.
Experts in Highly Appreciated Stock Strategies
As your portfolio becomes more concentrated and your company stock appreciates, it can be a financial planning burden. Ultimately, you will greatly benefit from the advice of a trusted executive financial advisor who has years of experience with both of these diversification strategies. With their help, you can effectively diversify your equity position while taking into account the taxation of your highly appreciated stock.
K. Wade Carpenter, CFP®, AIF®, ChFC®, CLU®, is an innovative wealth manager serving corporate executives and entrepreneurs from coast to coast. Throughout his more than 25-year career, Wade’s focus on C-level clients has made him a top strategist for equity compensation planning, including methods for handling highly appreciated stock in concentrated portfolios.
We specialize in equity compensation planning. Reach out today for a complimentary consultation with the Carpenter Team. We can meet with you in person or online.
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