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It’s bonus season. And that means lots of workers are amassing too much company stock, says John Voltaggio, a managing director with Northern Trust in New York. He spends much of March talking clients into diversifying.
As employees move up in rank, they start to get meaningful bonuses, usually comprised of more and more equity-linked compensation like restricted stock. Every March—in bonus season—employees get new awards and prior awards vest. That’s when you need to take stock of what you’ve got and what you’re due in the future. And look at the bigger picture. “Stop and look at how exposed you are to your employer,” Voltaggio says. “You should diversify on a systematic and disciplined basis. Even if you like the stock and like its prospects, sell it and hope it goes up, because you have so much other exposure.”
In a typical graduated vesting plan for restricted stock, 20% of shares might vest in year two, 40% in year three, until you’re 100% vested in year six. In the meantime, you get more valuable grants each year increasing your exposure. What most people do when they get a notice from say Fidelity that administers stock plans that says “60 vested shares have been deposited into your account, with 15 withheld for taxes,” is nothing. They hope it does well. “If the stock underperforms the market, that’s really going to have an impact on your ability to retire,” says Voltaggio. It’s that much more important for the rank and file to diversify as stock assets likely represents a big part of their portfolio. They can’t afford to take the single stock risk.
Start with an accounting, and you might be surprised at how concentrated you are in your employer stock. Add up any employer stock in your 401(k), outside taxable accounts (your employer stock can be hidden in mutual funds), in an employee stock purchase plan, restricted stock grants, and stock options. Are you participating in a nonqualified deferred compensation plan? If so, that’s subject to the company’s creditors. And add on the fact that your salary, benefits, and professional reputation are all tied to your employer as well.
Once you tally this all up, check out these five ways to rein in your exposure to company stock .
Rebalance your 401(k) investments. Set the allocation for future contributions into diversified funds, not your employer’s stock fund. If your employer puts your company match into a company stock fund, move it out on a regular basis. To the extent you already have company stock in your 401(k), consider selling it. If you get a notice from your plan administrator warning you that doing so might mean you lose “a valuable tax benefit”—the net unrealized appreciation break that lets you move employer stock into an IRA and save taxes on the appreciation, note that the NUA analysis is complicated, and in many cases people are better off diversifying, Voltaggio says.
Sell vested restricted stock. The concept is simple. At vesting, you sell net shares (with a full cost basis) without a tax hit. “Regardless of whether it’s $600,000, $60,000 or $6,000, if there’s no tax cost to sell, there’s no benefit to being concentrated,” he says.
Use ESPPs with caution. If you’re going to have company stock exposure via an employee stock purchase plan, you’ll want to be more aggressive diversifying elsewhere. And note that all ESPPs aren’t equal. See The Employee Perk With A Guaranteed 15% Return for how to assess your plan. The lack of a holding period makes an ESPP a definite win, but it’s up to you to sell the stock—or risk the ups and downs of the market.
Combine charitable giving and an overstuffed stock plan. If you’re sitting on a pile of vested restricted stock with a low cost basis, consider donating the shares to charity. You get a full fair market value deduction and never pay the capital gains tax on the appreciation.
Keep a close eye on stock options. You have to be even more proactive in selling in-the-money stock options. Waiting until the last day of the options’ life (usually 10 years) to get rid of them is risky. Voltaggio recommends assessing options strategies annually, and exercising stock options no later than three-quarters of the way through their lifespan. “You’re giving up leverage for the sake of diversification,” he says.
Why are employees hesitant to diversify? Market highs like we’re experiencing make people complacent, thinking their employer stock will continue going up forever. There’s also the possibility of looming tax relief under the Trump Administration—why exercise stock options now when the top tax rate is 39.6% if it might drop to 33% in 2018? Voltaggio dismisses these excuses. “Along the way, you’re carrying that specific stock risk,” he warns.
