Updated Thursday, July 24, 2014 as of 10:34 AM ET
Smart Ways to Scale Back Skewed Portfolios
by: Donald Jay Korn
Sunday, March 2, 2014
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“Naples, Florida, seems to be the retired CEO capital of the world,” says Steve Merkel, a financial planner with Ciccarelli Advisory Services, which is based there. 

Retired CEOs, like many high-net-worth retirees and corporate executives, often have portfolios heavily skewed toward a single company’s common stock, restricted stock, stock options, and so on. Such a concentrated portfolio leaves investors vulnerable to a mishap at one company that drives down the share price.

An obvious solution is to sell some shares from that single holding and reinvest elsewhere.  However, the concentrated position might include low-basis shares that can generate large taxable gains on a sale. Many HNW investors are also high-income so the tax on such sales can be painful, with clients facing the new 20% top rate on long-term gains, the 3.8% surtax on net investment income, and various phaseouts of tax benefits. 

How can such clients diversify without incurring a huge tax bill? Merkel says his preferred tactics fall into three categories.

1. GIFTING

The annual gift tax exclusion is now $14,000 so a married couple can give $28,000 worth of shares to each child, grandchild, and in-law this year, trimming their concentrated position with no adverse tax effects. Such gifting also gives away the low cost basis, but Merkel says clients accept this. “Often, the recipient will be in a lower tax bracket on a sale,” he notes. Moreover, the relative receiving the shares might not have such a skewed portfolio so there would be less risk in holding on to that company’s stock.

2. DONATING

HNW clients with charitable intent can contribute shares from a concentrated position to charity, getting a full deduction (if the shares were held more than one year) and avoiding the taxable gain. While family gifts or charitable donations or both trim the main position, new money can diversify into other holdings.

“If clients want income,” says Merkel, “the shares can be contributed to a charitable remainder trust.” The charitable trust can sell the shares and owe no tax, then reinvest in a diversified portfolio that can pay the client income for life. What’s left in the trust goes to a chosen charity, so the donor gets an upfront tax deduction.

3. SELLING

Merkel refers to a “five-year plan,” which is shorthand for a strategy that involves selling a majority of a concentrated position in yearly chunks over an extended time period. The client can specifically identify to the broker which shares are to be sold, so the highest-basis long-term shares are unloaded each year. This can result in a relatively small taxable gain, which may enable clients to keep reported income below the thresholds for lofty tax rates.

Merkel says that other tax reduction plans can help hold down the impact of selling appreciated shares from a concentrated position. “Investments in drilling funds can generate large upfront tax deductions,” he points out. “In addition, clients who have earned income from activities such as acting as a corporate director can set up a ‘Uni-k’ [a solo 401(k) plan] and make pre-tax investments up to $57,500 in 2014, to diversify away from the concentrated position.”

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