Diversify Your Concentrated Position: Help lower volatility, increase portfolio predictability and potential reduce taxes
Written by Terri Getman J.D.*, CLU, ChFC, RICP, AEP (Distinguished)
A hallmark of wise planning is to diversify risk across a range of assets and asset types because any one asset or asset class might underperform in a given year. Diversification can help offset underperformance. This risk can be magnified when an individual has a heavy concentration in one stock or asset. While capital gain rates are currently at near-historic lows and the stock market at an all-time high now may be a time to consider repositioning because President Biden campaigned on increasing capital gains tax – both during life and at death. Where an individual has a life insurance need, a life insurance death benefit might also help add stability to an overall financial plan.
DID YOU KNOW?
- Too much of any one company’s stock increases your exposure to company specific risk and stock price volatility.
- President Biden campaigned on replacing the 20% capital gain tax rate with ordinary income tax rate of 39.6% for incomes of over 1 million and eliminating stepped-up basis at death.
MEET JOHN, CEO OF XYZ Inc. – Age 55, nonsmoker, in good health
John currently owns $2 million of XYZ stock (48,780 shares at $41 per share with a cost basis of $15.98 per share). He’s concerned that his current concentrated stock position exposes him to higher levels of market and price volatility. Based on his objectives, net worth, time horizon and risk tolerance, this large position is more than he is comfortable with. John receives $980,000 in wages.
Despite his continued interest in the market returns, John wants a way to:
- Minimize his risk exposure to market volatility.
- Leverage his legacy to his children.
- Reduce risk associated with economic and tax uncertainty.
IF YOU HAVE A CONCENTRATED POSITION LIKE JOHN-
Here’s what John’s advisor recommends: Liquidate $1 million $3 million – Stock Portfolio
- John sells 24,390 shares of XYZ stock at $41 per share for $1 million. Today he pays a 20% federal capital gains tax, a 3.8% Medicare tax on investment income for federal tax of approximately $145,2391.
- If John waits to sell his large concentrated stock position and President Biden’s proposal on capital gains is enacted into law John could pay a 39.6% tax rate on the gain of approximately $241,658. After paying taxes based on the $15.98 per share cost basis, John uses some of the remaining $854,761 to buy a life insurance policy.
- By selling just a portion of his stock, John reduces his concentrated risk and protects his legacy with a legacy with a death benefit that can pass to his children/family income tax-free.