If you’ve identified that your investment in company stock represents a concentrated position, there are a few ways to help mitigate the risks. Consider the following strategies as you decide what to do next:
Be thoughtful with holdings in a retirement plan. You can sell stock in a 401(k) or other retirement account without near-term tax consequences. Therefore, most people should periodically diversify into other investments.
If the company stock in your retirement plan is highly appreciated, however, you may want to hold it until leaving the company and then consider a strategy known as net unrealized appreciation (NUA). The strategy involves transferring appreciated company stock into a taxable brokerage account, while rolling over other holdings to individual retirement accounts (IRAs). While you would pay ordinary income tax on the cost basis at the time of the transfer, you can qualify for favorable long-term capital gains tax rates on the appreciation when you sell the shares. That gives you an opportunity to address any concentration issue in a more tax-efficient way. A host of tax and plan-specific rules apply, so be sure to consult with a tax professional or financial planner.
Sell restricted stock upon vesting. With restricted stock, an employee does not receive shares immediately—vesting requirements such as passage of time or fulfillment of performance goals must be met. Typically, the value of the stock is taxed as ordinary income once the shares vest. Therefore, there could be little or no additional tax liability if you sell restricted shares shortly after they vest. This strategy reduces an employee’s overall exposure (including unvested holdings) and helps prevent the risk from getting bigger if new grants are received.
Consider your stock options. Stock options allow employees to purchase stock at a “strike price,” typically the market price at the time they are granted. Therefore, the value of employee stock options depends on future appreciation, and is thus difficult to estimate, especially if the options don’t expire for many years. Despite that uncertainty, it is important to monitor the intrinsic value (market price minus strike price), as well as future potential gains. “Don’t ignore them,” says Young. “And make sure you consider how future transactions such as grants and exercises might affect your concentrated holding.”
When it comes time to take advantage of valuable options, consider a “cashless exercise,” if that method is offered to you. That alternative facilitates a transaction where the shares are purchased and immediately sold without the employee having to come up with cash upfront. Both the purchase price and the taxes are automatically paid from the sale proceeds, helping avoid a large tax bill at the end of the year.
Use a rules-based approach to managing holdings. Employees with large holdings of company stock can employ a systematic process to determine when and how to sell their holdings. That system could be based on share price and the value of their position relative to their overall portfolio. This strategy can help remove emotions from the decision-making process.
Certain executives can establish a formal plan, known as a 10b5-1 plan. This approach would be most appropriate for leaders subject to public reporting requirements who often learn material nonpublic information about the company. By giving up direct control over transactions, executives can avoid running afoul of the SEC’s insider trading regulations. There are many decisions to make when designing these plans, so coordination with the company’s legal counsel is critical.
Ultimately, the approach to managing a concentrated position of company stock is the same as managing other risks in your portfolio. The key is being aware of the risk and taking the steps necessary to manage it at a level that is appropriate for your situation. “Don’t think of this as a matter of loyalty or confidence in your company,” says Allenbaugh. “It is about managing your portfolio risks to achieve your long-term financial goals.”
