SPEAKER_00 0:32

Welcome back to the Sandwich Red Podcast. Today we're diving into a subject that impacts a growing number of families given that the markets are trading near all-time highs, and that is concentrated and highly appreciated. We will unpack different considerations and strategies for unwinding concentrated positions with tax impact in mind. I'm also excited to have Lauren Knows, Director of Operations at Twin Robins, MCing this episode. We always recommend consulting tax or legal professionals as needed, but that is especially important with today's topic. All right, let's get into it. Welcome back, everybody, to another episode of the Sandwich Bread Podcast. I'm your host, Tom Kaminsky. As mentioned in the introductory credits, this is a special episode. We have a co-host. Welcome, Lauren. Hi, Tom. And for those that don't know, Lauren runs operations for Twin Robins, and many of our clients know her and interact with her on a regular basis. Today's episode was born out of a series of client conversations. So wanted to put together a podcast to address our framework for thinking about it. The specific topic in mind is highly appreciated concentrated stock positions. So we encounter that with our client base. They're often young professionals and often in the tech sector. But with that, let's jump into the let's jump into the subject, Lauren.

SPEAKER_01 1:53

All right. Tell me about what a concentrated stock position is when you see it. And then what do you do when you see it? Yeah.

SPEAKER_00 2:01

All good questions. And like a lot of things in financial planning, it's not like a perfect answer to those questions, but it never is. Never is. But let's unpack that question in parts though. What is a concentrated stock position? So a concentrated stock position, I look, I think of it as an individual security. So one stock, and when I say security, let's let's call it one stock that represents a disproportionately large percentage of your portfolio. What is disproportionately large? Very good question. I generally signals to me that it could be concentrated or becoming concentrated when a single holding represents, call it three to five percent of your portfolio or larger. And that's when you start to see it sort of stretch the impact it has on your portfolio, good or bad, in a pretty significant way. Um so at a high level, that'll kind of meet a lot of textbook definitions that you'll see out there. However, I I look at this very, very tailored to your unique financial planning situation. Let me give you one example where by the textbook, a position might be concentrated, but it does not cause me worry. Okay, let's take a so let's take a family. Say they have two working parents and have a reasonably high income. They aren't big spenders and they live well within their means and they save reasonably well compared to that. And let's say they have accumulated quite a bit of retirement assets and maybe even some taxable assets, such that they're almost at the level of financial independence, right? Like they could almost retire today and they're maybe they're mid-career working professionals. So that's over here, and it's a diversified portfolio, broadly diversified, international stocks, domestic stocks, bonds. But let's say they have just the same amount in one single stock. So we've got$4 million in this diversified portfolio over here. Let's say we have another$4 million in just one single share of stock over here. So that's$50-50. Right? That's a lot of concentration by the textbook definition. But if that stock went down to zero, would they be harmed with their financial plan? By everything we built out and analyzed, they'd still meet their financial goals and they'd be okay. So you have to look at it very carefully. There's no hard and fast rule. 3% to 5% is sort of when it starts to impact the portfolio performance in a meaningful way, but you have to look at the much bigger picture. And then there can be situations where even a smaller percent, 3 to 5%, could harm their financial plan in such a way that we really need to work on getting rid of that. So there's nothing uniform with this, but that's at least a triggering moment where I look at a client's portfolio, I'm analyzing it as I get to know them, you know, and I see a single holding push that that limit, that's where it starts to signal to me it might be concentrated. We need to do a deeper dive into it.

SPEAKER_01 4:47

Okay. So you've established that someone has an outweighted, concentrated position in their portfolio. You've identified that it's putting their future financial independence at risk. What are the options?

SPEAKER_00 5:03

Good question. And let's also add that caveat of highly appreciated in there too. That's an important component of this because they have different hypothetical family. We'll we'll keep track. Family A is done. This is family B. Uh, family B worked at a tech company and they granted you a ton of stock 10 or 15 years ago, and your company has has done what a lot of large tech companies have done over this time frame. It could be very highly appreciated. If it's not highly appreciated, it's trading near its cost. Unwinding that, at least from the tax perspective, is not too painful an experience. But it's usually that tax pain that that causes people to hit pause and say, what can I do? Am I stuck with this? So, yeah, good question. And we have a framework for thinking about this that and that we run client situations through to try to come up with the best solution for their unique circumstances. And I'll add the caveat, you'll hear it a couple of times throughout this podcast. Everything is super unique to the family. And also a lot of this involves heavy tax and a heavy legal considerations. Be sure to include your accountant in these conversations. Be sure to include your uh uh estate planning attorney in these conversations, and certainly include your financial planner as well. This is really important from a collaboration standpoint with the team of professionals that support you. All right, so options to on what to do with a highly appreciated concentrated stock position.

SPEAKER_01 6:27

Yeah, what's the first one that you would say? And these are in no particular order, right?

SPEAKER_00 6:31

These aren't in order of favoritism. I don't have a favorite. Let's just start with option one. And this category is called tax loss harvesting. And so by definition, tax loss harvesting is using losses from an investment position and harvesting those, which means selling them and realizing those losses, which requires a certain waiting period of time before either buying back into that same position or something else. So basically you're creating loss through the sale of a capital asset. Now, with a concentrated stock position, what we could potentially do is say you've got a portfolio with a number of investments in it. You got your company stock that's highly appreciated. You have some positions over here that actually have some losses in them. And you may still like those positions. You may want to buy them back later, but you can leverage those potentially to offset the gains in the concentrated stock position. So you're selling at losses over here and trying to match that with the gains you're generating over here. From the single stock. From that single stock. Yep.

SPEAKER_01 7:29

So you're taking a completely different stock from within your portfolio that is not succeeding or it's trading for less than what you paid for it. You're selling that and then taking that amount of loss and offsetting it against the gain in the stock that you're content. That's correct.

SPEAKER_00 7:50

Yep. And there's careful tax considerations for this because if it's a long-term or short-term capital gain versus a long-term or short-term capital loss, there's a priority ranking. We don't need to get too granular with that, but you need to be careful on that to make sure the losses match up appropriately with the gains and you're not getting caught. And also be mindful of wash sale rules. But wash sale rules dictate that you need to not buy or sell a specific security that is similar enough to the one you're buying or selling within a certain certain window of time, or it'll basically disallow the loss that you've generated. So a lot of careful considerations around this, like everything. But this is one of one of the techniques we we use quite often with clients because it doesn't require too much more sophistication besides what we have discretion over as the advisor managing the money. We we can see everything very clearly. We can discuss their wishes and wants from a concentration standpoint, from a tax planning standpoint, engage their accountant, and we can put together a plan that we can control, which which helps get it done more efficiently. So we'll call that great. Yeah. Oh, sorry, Lauren. Go ahead.

SPEAKER_01 8:57

Is this something that happens quickly or is this something that typically is going to take a little bit of question?

SPEAKER_00 9:04

It can be both scenarios. If there's losses embedded and ready to go, um, and we have positions that we want to move out of on one side of the fence, and we have gains on the other, we can we can act pretty quickly. If there isn't, but we know this is the strategy we want to use, we will do this proactively over time. We'll monitor the portfolio. And sometimes it can take years and years. So it's it's not easy when there aren't gains ready or losses ready to go. It just takes time. Good question.

SPEAKER_01 9:32

Okay. Great. What is the next one?

SPEAKER_00 9:34

Next one is direct indexing. And and this is sort of a partner to tax loss harvesting. So we'll call the first definition I gave there a scenario where we inherit a portfolio and we want to manage it, Twin Robbins ourselves, uh, the unwinding process and the loss generation process. Direct indexing is a product that has been around for some time, but it's gotten more popular over the last call it decade as technology has improved and the solutions have gotten lower cost and more accessible to so what is direct indexing? Well, a lot of investors own mutual funds or ETFs, exchange traded funds that mirror an index. And what they're trying to do to the best of their ability is replicate their benchmark index with as little tracking error as possible. Direct indexing tries to do something somewhat similar, but they essentially unpack that mutual fund or ETF wrapper, and you're buying the individual underlying shares of that product. So call it the S P 500. You may own an S P 500 ETF. That's one security that you're purchasing. In a direct index, you're purchasing 500 individual companies trying to be weighted to the best of the direct indexing solutions ability to mirror the S P 500. So you're owning 500 individual companies. What this allows the technology to do is tax loss harvesting on a much larger scale. It's monitoring those 500 securities for the ebbs and flows in stock price actively throughout the day. And it's trying to capture those losses as there's dips in prices and accumulate losses for the portfolio on paper. So they're trying to somewhat stay as close as possible to that benchmark index, but generate losses and churn out losses using harvesting technology. And then that's like one bucket. You've you've got a direct index over here, and then you've still got that appreciated stock over here. While we're using these losses being generated by this product to then wind down the concentrated stock position. So there's pros and cons to this. So costs are coming down. Cost used to be a little bit of a barrier to this. Performance is getting better, but typically I'll see issues on the performance side of things and tracking the benchmark index, although that's not the primary goal for using these products. So I don't lose a ton of sleep over that particular piece, but you want the performance to be as good as possible. But costs are coming down, but there is another layer of cost to the product use. And I typically see over time and in my research that the losses you're able to generate within the direct indexing product are tougher to generate as time goes on. Essentially, they use up the losses, the ability to lose money, and you're eventually left with mostly gains in the portfolio. So if you're not consistently reinvesting and adding money more and more to the direct index, you may have a situation where you don't have a lot of losses left to generate. So it makes it a little trickier to offset the concentrated stock position over time.

SPEAKER_01 12:30

Okay, great. So that is direct indexing. And then what is next on the list? And again, not in any order, no favorites here.

SPEAKER_00 12:39

Certainly no favorites, yeah. Uh the next is a little bit more of a sophisticated process. It's called using an exchange fund. At a high level, because this is quite sophisticated, you're essentially contributing your appreciated stock into a pooled fund in exchange for a unit of partnership in that fund. There's a required holding period, you know, which goes out years, and eventually you're able to redeem it for a basket of diversified stocks. So honestly, the the non-starter with a lot of my clients is the holding period. And that kind of generally ends the conversation, but that doesn't mean it's not appropriate for a listener. You may have the right circumstances where exchanging your concentrated stock for an into an exchange fund is the appropriate move to make. A couple more of the drawbacks related to exchange funds, there can be higher fees, costs, administration for those products. And you may not have, because what they're trying to essentially do is accumulate concentrated stock positions to fill gaps or needs in the fund that they're building. You may not have the diversification you're hoping to achieve within the product. So that can be a challenge as well with this particular solution.

SPEAKER_01 13:48

All right. What is up next?

SPEAKER_00 13:50

All right, next up, options overlay. So this strategy involves options trading, which is at a high level, buying and selling contracts on the expectation of a future stock price. And it, I'll start by saying the important asterisk here is that you should always engage an investment professional if you're going to use one of these strategies. They are, they can be highly risky if you don't know what you're doing. And you need to be very careful whenever leveraging options trading. But it can be a really powerful risk mitigating strategy if done correctly. So a couple quick uh high-level scenarios. I won't get in the weeds on how it all works because that could be a 30-part podcast. Um, but at a high level, you can you can pay for an insurance contract to create a floor on a share price if you don't want a stock to go below a certain amount. Uh, you could generate income by selling calls on a on a share of stock. And again, you could use that, it's called premium. Use that premium to offset potential capital gains you would pay if the stock were sold. Right? That's another strategy. Third would be building what's called a collar where you're selling calls and simultaneously buying puts. So you're buying on both sides of the stock price, and you use the income from the calls to cover the premiums for the puts. So it's not a lot of cost out of pocket in some situations, and you're essentially creating guardrails. You're creating an upper and lower buffer for a stock price. So I'm just giving you like the super high-level explanation of different strategies.

SPEAKER_01 15:14

Yeah.

SPEAKER_00 15:15

But they can be highly effective for clients with concentrated stock positions when it's appropriate for your specific situation.

SPEAKER_01 15:22

Yeah. And that would be a a way to potentially keep the stock if you wanted to, but to kind of protect yourself.

SPEAKER_00 15:31

Very good. Potentially, right. And and in the a situation where you're selling a call, you can lose that stock, right? If it moves outside of those guardrails, it can get pulled away from you without your ability to stop it. Um, and you just so you need to be fully aware of what you're getting into and understand the pros and cons of of the decision, but it can be an option. Pun intended.

SPEAKER_01 15:51

There we go. Okay. Um, all right, what are some other tools available?

SPEAKER_00 15:56

Uh this one is the least creative, but I find it very satisfying and also very good for a lot of situations, and that is slowly selling the stock. That's it. That's it. If sell it slowly. If if the stock is going to be a big tax hit for your specific year and you're working with the tax professional, and they said this is a bad year to sell a bunch of this stock, but you really want to trim it over time. Um, maybe you can swallow those capital gains hits a little bit better if we spread it out over a number of years. And just chip away. And and don't reinvest the dividends and buy more of it and create more problems. Yeah, that's that's not helpful if you're reinvesting and buying more shares than we're selling each year. But slow selling is is not bad. And and you know, if you have opportunities to harvest to offset it, that's great. But just having small little capital gains hits over time is not a bad way to go. And then after a number of years, you kind of get it back in range. That's the goal. Yep.

SPEAKER_01 16:52

Well, we just talked about slow selling. Um, what else do we have at our disposal?

SPEAKER_00 16:59

I will I will reveal some bias uh with this next one. This is one of my favorites charitable gifting. So it's my favorite for a couple of reasons. One, it's good to give, uh, or at least I think we want that to be noted. Yeah. We're we're all work in progress. We're all work in progress.

SPEAKER_01 17:18

Next sentence. Yes.

SPEAKER_00 17:19

This is this is one of my favorites for a couple of reasons. One, I like it when clients give and support charities and other things that they're they're passionate about. Um, but there can be a number of tax advantages with charitable gifting as it relates to appreciated stock. So I'll I'll delve into two different kind of pathways to follow.

SPEAKER_01 17:37

Within the realm of charitable gifting. Okay.

SPEAKER_00 17:42

All right. So first thing we'll talk about with charitable gifting is direct gifting. And that means literally giving your appreciated stock directly to a charity you care about. This is good for a couple of reasons. First of all, you're you're not going to realize those capital gains as long as you don't sell it. If you're giving it directly to the charity, you're passing that basis along with it. And then you're getting the full write-off for the gift. Now, there's there's some important caveats to that. There are limitations on the percentage of your AGI that you can get a charitable write-off for. You may not get any write-off if you're using the standard deduction versus an itemized deduction. So this is certainly one where you want to engage your tax professional and say, in what way will this gift benefit me? But I have seen scenarios where clients are standard deduction, have a highly appreciated stock and say, Well, I have cash I could give, or I have this stock I don't want to hold in onto. And they're just, they're giving the stock because they're at least foregoing the capital gains. So they're not going to benefit from either gift from the standpoint of itemized deductions, but they look at that stock and go, well, it's technically more tax efficient, even if I'm not getting that itemized deduction. So direct gifting can be a great way to go. Check with the charity in advance and make sure they have the ability to receive those stock gifts. Some do, some don't. So make sure it's a good fit. I would add to that, Lauren, is that you want to make sure with your tax professional that you would, in fact, get a deduction for donating to that specific organization. So that's an important one to verify in advance as well. So it's a great way to go. Another non-charitable consideration would be gifting to family members that are in a lower tax bracket than you. If you want to give them something and let them have it and sell the stock, if you're of certain income levels, the capital gains rate can be 0%. Um, again, not tax advice. You want to check all this with tax professional in advance. If you're in, you know, if you're a very high income level, you could be looking at 20% capital gains rate plus a 3.8% net investment income tax rate on that. So 23% total tax on that, gift it to somebody in a lower tax bracket, they could uh potentially pay almost zero on it. That can be a really tax-sufficient way to give to others in your family, not necessarily charitable. Well, some people call giving to family members, but that's a consideration as well. Now, the next methodology, which I like to leverage when it's appropriate in concert with tax professionals, is what's called a donor-advised fund. A donor advice fund is a charitable investment account run by a public charity that allows you to irrevocably contribute into it. And you could do that with cash or you could do it with an appreciated stock position. So you're giving into this charitable fund, and then you, as the trustee to that, your specific donor advice fund can help direct future gifts out of the fund to qualified charities. So maybe you want to give, but maybe you just don't have your plan figured out, or you want to give over time. You can do something very clever, which is called bunching your gifts, giving a larger amount of appreciated stock in a single tax year to maximize the possible deduction you could get, and then distributing out of that fund over time. And there's a lot of mechanics. Okay. Over years, over years potentially. And so a lot of these donor advice fund products are really interesting. I mean, they allow you to invest inside of that fund. So you can actually even grow your charitable gift balance as you're distributing out of it over time. Um, so yeah, it's really interesting. I mean, I have some clients who give small amounts every year, which is wonderful, but they're not getting any tax benefit from that. And I'll ask them like, you know, you you give to charity, it's wonderful. You've got these select organizations you give to. Are you going to give to them indefinitely? And they'll say, Well, yeah, yeah, we love supporting them. I'll go, well, let's get your tax professional involved, but could we consolidate and do all these gifts from a tax planning standpoint in a single year and then distribute to that very same charity over time where you actually get a write-off?

SPEAKER_01 21:38

At the same rate you usually do weekly, monthly, quarterly, exactly.

SPEAKER_00 21:43

Yeah. And so they love it, right? And and it it turns something where they're not getting a write-off into potentially a write-off. So that's that's usually really exciting when when we can kind of create those opportunities for clients. And there's sophistication to it. It's an irrevocable gift. You want to make sure the charities you give to are qualified, you know, coming out of the donor advice fund. A lot of pieces to to kind of navigate there. But this is certainly one where it's a nice collaborative experience between your financial planner and your tax planner that can make this really impactful. Yeah.

SPEAKER_01 22:15

Great. Um, I think we have time for maybe one more.

SPEAKER_00 22:17

That's great. Last but not least, estate planning strategies. So I'll keep this one extremely high level so it does not get misconstrued as advice in any way. But there can be several different trust design strategies related to appreciated. Stocks. And so engage your estate planning professional. This is another one where state, tax, and financial planner all working collaboratively together can create some really cool outcomes for you. But engage potentially your estate planning attorney if you have an appreciated stock position and you really don't know what to do with it. There can be estate strategies to consider. And then the other strategy related to estate that I will shine a little bit of a light on is tax code as it's written today allows for a step up in cost basis upon death when you're gifting your stock to uh your beneficiaries. So if you've got a stock that you bought for a penny and it's worth$100 of share, and um you you're late in life and you really don't want to sell the stock, you could consider just holding it and leaving it to your beneficiaries and they'll get that step up in basis.

SPEAKER_01 23:25

So that's the way the rule meaning that when they get it, their basis goes to a dollar as opposed to a penny. Exactly.

SPEAKER_00 23:33

It'll rise up to the value of the stock um on the data.

SPEAKER_01 23:39

Where it is. And so um Okay, as opposed to if you just gave it to them during their lifetime, that person would then assume your original basis of one penny in the state.

SPEAKER_00 23:51

Exactly right. Yep. And that's not a reason to gift during life or not gift during life. And if giving now is more appropriate, certainly consider that too. So um a lot of considerations there. But the way the rules are written now is that you get a step up in basis upon passing, and that can be a way to give, transfer your assets to whoever you wish your beneficiaries to be, and and they essentially get like a wipe out of that low basis.

SPEAKER_01 24:17

Okay, great. Moral of the story here is there's no one way that works for everyone, right? And to make sure something is the right kind of strategy for you, you're gonna wanna get your your A team involved, right? Your financial planner, your your CPA, your state attorney, but there's options available. And it's a good problem to have, right? You have concentrated stock, but there's there's a lot of options for that.

SPEAKER_00 24:45

I think that's that's a nice bow to tie on it, is if you've got concentrated stock, you do have options. And it's really smart to engage your professionals, tax professional, estate planning attorney, and financial planner. Uh, this is a good situation where collaborative teamwork can can help immensely. And uh they can point you in the direction of the right answer for you right now. And uh also know that that that answer might change over time. It always does. Um yeah. So we just wanted to use this episode to shine a light on some of the different things we consider for our clients and uh hope you enjoyed the episode. All right, have a good day.