More employers are offering equity options within their compensation plans to retain top talent and incentivize performance. From managing your tax liability to your overall investment risk, it’s crucial to understand how these options work to make the most of your shares, particularly if you plan to retire soon. We’ll explain six common mistakes to avoid before your retirement if you own company stock, restricted stock units (RSUs), or stock options.
#1 Keeping All Your Eggs in One Basket
Holding too much company stock or not moving away from a concentrated position can be risky, as your retirement nest egg could be tied to one company’s performance, thus having all your eggs in one basket. You can avoid this by diversifying your portfolio. For example, consider selling some of your company stock and investing in other asset classes expected to perform differently than the company stock. Diversification should serve you well in your retirement years when you’ll likely want less volatility in your portfolio and a more predictable source of income.
#2 Selling Too Much, Too Soon
If your company stock has appreciated significantly, it may be tempting to sell as soon as you retire. However, this can be a mistake if the stock is still expected to grow over time. Instead, consider holding on to some of your stock for possible future growth. One strategy we’ve shared with clients is to sell a piece of the shares upon retirement, sell another portion later, and keep the remainder for the long term, provided that it is less than 10–15% of your overall portfolio.
#3 Not Considering the Tax Consequences of Selling
You may be subject to capital gains taxes when you sell company stock. Consider the tax implications of selling your shares and try to minimize your tax bill by using tax-loss harvesting or selling stocks in a tax-advantaged account. You may plan to sell some of your stock to diversify or handle spending needs. Consider if you can delay some or all of the sales until the years after you retire, when your taxable income may be lower because you’re no longer working. The taxable gain from the sale will be added to a lower income amount, so you might be able to reduce the overall tax cost of the transactions. If you have extremely low basis shares through your company stock grants and are charitably inclined, you can also consider gifting options to help defer some of the capital gains.
#4 Not Exercising or Vesting Company Stock Options
If you have stock option grants that are either unvested or unexercised, you will likely lose those shares upon retirement. So ensure you understand the terms of each grant to leverage and potentially maximize your shares before you officially retire. For example, you may consider exercising your options and selling the stock immediately before or after retiring.
#5 Not Evaluating Net Unrealized Appreciation (NUA)
NUA is a tax strategy for company stock in an employer retirement plan, such as a 401(k), allowing employees to receive a tax advantage when they retire and begin taking distributions from their plan. NUA is the difference between the cost basis (the price you paid for the stock) and the stock’s market value at the time of distribution from the 401(k) plan. In other words, NUA is the appreciation of the stock that has yet to be taxed. When the 401(k) distributes the stock, the cost basis is taxed at ordinary income tax rates while the NUA is taxed at the long-term capital gains tax rate, which is usually lower. This benefit is why NUA is worth considering for retirees with a large amount of company stock in their 401(k) plan who expect significant appreciation in the future. NUA is also a good strategy for retirees who are in a high tax bracket while working but anticipate being in a lower tax bracket in retirement. Read more about the benefits of NUA.
#6 Not Considering Your Overall Financial Picture
Retirement planning is not just about your company stock—at least it shouldn’t be. Make sure to consider your overall financial picture, including any pensions, Social Security, other assets, and your tax situation when deciding what to do with your company stock. If you already have a diversified portfolio with multiple sources of income, perhaps you can hold on to your stock. Alternatively, consider the guidance and strategies in this post if you only have company stock.
Remember, these are general guidelines; you should always consult a financial advisor or tax professional for personalized advice based on your financial situation. Contact our team, as we’re happy to have a conversation with you about your company stock as you approach retirement.
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CCMI provides personalized fee-only financial planning and investment management services to business owners, professionals, individuals and families in San Diego and throughout the country. CCMI has a team of CERTIFIED FINANCIAL PLANNERTM professionals who act as fiduciaries, which means our clients’ interests always come first.
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