Thoughts on transition: Stock options -> balanced AA in prep for FIRE

[Pacinotti]

Hi guys,

I've been voraciously reading the forum since I discovered it a few weeks ago. Incredible wealth of knowledge. I hope to contribute at some point.

Would love to FIRE in the next 3-4 years.

Here's my situation (and sorry I don't know all the acronyms yet...):

• I'm 58 DW is 53. Sole earner; still working and contributing max to 401(k)
• 401(k) is at $1.7M and other liquid investments at around $425k
• Company stock options valued at ~$1.6M, very highly appreciated
• The vesting schedule (meaning last year i could sell. Options expire 90 days post leaving company) is as follows:
• $530K 2020
• $415K 2021
• $360K 2022
• $180K 2023
• $85k 2024
• $50K 2025
• In addition, I own company stock valued at $1.7M, most of it long-term appreciated.

Sorry, I pressed submit by mistake...
So my question is, what would be a good tactic to convert all of this company stock into stable AA of 60/40 or 50/50.

My thoughts are that there is not a lot of leeway with the options so sell them all in equal chunks over the next 3-4 years to minimize taxes but what about the stock I own... Keep it and divest it slowly to stay at 15% capital gain tax rate?

Further, I would also like to stay under the ACA cliff until we hit 65 which means not doing all this cashing out of stock after I am FIRE'd, given they are very highly appreciated...

Thoughts? Thanks in advance!

 

[HI Bill]

So, you own $1.6M in company stock options AND $1.7M in company stock? I calculated that 60% of your retirement assets are in your company stock. My main goal would be to divest myself of company stock as quickly as possible, as your lack of diversification puts you at immense risk in retirement. But with your vesting schedule (and high amounts), you really do seem to have limited options, without hitting the top two tax brackets. With your age and current lopsided allocation, there's an immense risk to your retirement assets.

I would come up with a divestment plan that smooths the taxes from your retirement year until the assets are gone, hopefully, in eight years or less. I'm not a tax accountant, and I've never dealt with the top tax brackets, so I'd suggest consulting a really good tax person.

I believe that the risk of not starting the divestment of company stock as soon as possible far outweighs teh ACA cliff. That shouldn't even be a consideration, at your asset levels.

 

[brett]

I placed protecting my investments/options above tax liabilities. Worked with a tax specialist to map at a tax efficient plan going forward.

I exercised at $54-$40. Stock kept going down to $17. So glad I decided to protect my retirement funds and not focus on the tax implications.

 

[brett]

I placed protecting my investments/options above tax liabilities. Worked with a tax specialist to map at a tax efficient plan going forward.

I exercised at $54-$40. Stock kept going down to $17. So glad I decided to protect my retirement funds and not focus on the tax implications. Pulled out $1.5 that might have otherwise been lost in the market. Perhaps not big number to some people but to me it was. Plus, instead of depreciating, that $1.5 was placed in the market and grew very nicely.

 

[OldShooter]

... your lack of diversification puts you at immense risk in retirement. ...

+1 "Prudent man" criteria used by professional trust administrators consider anything over 10-15% of assets in one security to be an imprudent concentration. Think Enron, GE, Sears Holdings, ...

 

[Idnar7]

I was retired in 2010. I still had outstanding stock options. When I cashed some in the SS tried to call back SS payments. They were going to withhold like 15k of my SS income. I wrote a letter to them saying this wasn't income, but was deferred income. Eventually they agreed and I didn't get penalized. But it could have gone the other way. I would cash in your options before you claim SS.

 

[OldShooter]

I was retired in 2010. I still had outstanding stock options. When I cashed some in the SS tried to call back SS payments. They were going to withhold like 15k of my SS income. I wrote a letter to them saying this wasn't income, but was deferred income. Eventually they agreed and I didn't get penalized. But it could have gone the other way. I would cash in your options before you claim SS.

We had the same thing happen with DW's stock options because the income shows up on a W-2. It was a fairly simple matter to get it corrected. OP, I would touch base with your CPA on this but probably it is nothing to worry about.

 

[pb4uski]

....So my question is, what would be a good tactic to convert all of this company stock into stable AA of 60/40 or 50/50. ....

Absolutely, you are way overconcentrated in company stock right now which is very high risk to your financial future should something bad happen that is company specific... but you already knew that.

Figure how much you can sell for 15% capital gains tax and get to it... perhaps even 20% if you have to... that extra 5% tax on the gains will seem minor if your company stock takes a slide.

Let's say you have $100.00 and your basis is 25%... your gain is $75.00 and at 15% your tax is $11.25 so your after-tax proceeds is $88.75. At 20% your tax is $15.00 and your after-tax proceeds are $85.00

Let's say you pass on the sale at 20% to save $3.75 of tax and the stock subsequently goes down 10% to $90.00... then your gain is $65.00, your tax at 15% is $9.75 and your net proceeds are $80.25. $85.00 is better than $80.25. Even with a 5% decline you would still be better off paying the 20% tax on the $100.00 sale than holding out to pay 15% tax on the $95.00 sale.

You can model out your situation to get an idea as to the sensitivity.

 

[pb4uski]

With your taxable account assets... well over $3m... you may not be able to keep your income under 400% FPL of $65,840 for a couple (2019) and qualify for ACA subsidies.

You might be better off forgoing ACA subsidies and aggressively reducing your tax-deferred money while you are in a lower tax bracket (before any pensions, SS and RMDs start).

 

[RunningBum]

Agree with the sentiment here, goal #1 is to diversify, and quickly. I had an FI amount disappear on me in the dotcom bust. Took years to recover. Are these the kind of options that will get taxed as regular income, or as cap gains? Not that it matters too much for the diversification advice, but just realize that $1.6M in stock options taxed as regular income is really only worth about half that, after taxes. I would start selling off a big chunk each year.

You're going to need to setup a spreadsheet to decide whether going for an ACA subsidy is better than converting a lot of that 401K to a Roth. It'll involve some guesswork on what your subsidy would be, and forecasting tax rates.

To keep the subsidy possibility alive, when you exercise the options, put the proceeds in tax efficient funds. Managed funds with erratic CG distributions are not this. Think Index funds. VG (and probably others) even have tax efficient index funds. Individual stocks that don't have high dividend yields are another option, but don't forget to diversify.

Then think about how you are going to fund your expenses each year until you reach medicare. As those funds start to appreciate, you may not be able to sell off some funds to raise money without taking a big CG hit, which could put you over the ACA limit. I set up a CD ladder. I take some taxable hit on the interest, but it's very predictable and keeps me under the limit. My exposure is that as my index funds grow, they throw more dividends and creep me toward 400% FPL.

Bonds are less tax efficient, so keep those in your 401K or IRA.

My guess is, given the large tax hit on the stock options, you'll be able to get the ACA subsidy and do small Roth conversions. In a year where the subsidy is not large (maybe under $200-250/month?), forego the subsidy and make a larger Roth conversion.

 

[OldShooter]

IIRC the gains on DW's exercise of stock options were ordinary income, not CGs.

 

[kgtest]

Watched the ole mans company stock slide from over $20 a share, down to 15...and then under 10...finally convinced him to cut the cord loose at $8. That was in a matter of 5 years. It happens so quick.

Wiped away about 1/3 of his invested assets.

 

[RunningBum]

IIRC the gains on DW's exercise of stock options were ordinary income, not CGs.

It depends on whether they are ISO or NQ.

 

[brett]

I was 58. Had a great golden handshake that we could easily live on for four years or so. Met with our financial adviser.

His very first suggestion concerned the remaining options in my account. Simple question, now that you are retired would you ever consider having this much of your retirement equity tied up in one stock? Obvious answer was no.

Second question was if these options expired or went below the strike price would it impact the retirement your retirement vision.

Next question....how do you think the company, the market, and the industry will fare and what is your degree of certainty/probability. I misjudged this. I thought that the stock would increase as per the pundits. I was wrong. It started a gradual slip to the basement.

It was IT. We immediately started to cash out the options. Several of my former colleagues rode theirs down to, and below the strike price. I happily paid the tax. The impact on our retirement has been positive.

 

[Toocold]

I had a similar situation, in which 33% of my net worth was tied to vested stock options. I did not have company stock. I chose to increase my non-qualified deferred compensation contribution (which reduced tax obligations) to mitigate the impact of exercising my stock options. In essence, I theoretically "converted" my vested stock options to company bonds, which is safer although still tied to the company, and plan to use it to help bridge between when I leave the company and 65.

Similar to what others have advised, having 67% of investments tied to your company's performance seems risky and I agree with you to diversify by selling company stock and start offloading your options. A conservative 50/50 AA is good given that stock options are derivatives so they have high volatility.

 

[pb4uski]

I wonder if there is a way to hedge these company stock options... perhaps by writing at the money puts whose gain would offset the loss on the stock options.

 

[flintnational]

I agree with the others. The biggest risk to your retirement is not taxes or lack of ACA subsidies. It is large percentage of assets in a single stock. I would prioritize diversification and make the ACA and taxes secondary issues.

 

[brett]

Bottom line.....you are very fortunate to have an opportunity like this. Take advantage of it. Don't waste it. Remember the old saying.....'pigs get slaughtered'.

 

[pb4uski]

Actually, I think it is pigs get fat and hogs get slaughtered.

Don't be a hog.

 

[Ronstar]

I agree with the others. The biggest risk to your retirement is not taxes or lack of ACA subsidies. It is large percentage of assets in a single stock. I would prioritize diversification and make the ACA and taxes secondary issues.

+5 or so

 

[Pacinotti]

Thanks for all the comments.

 

[thepalmersinking]

I think of my options as found money. I certainly do not let them go I exercised each year. When I retire, selling them all is #1 on my go do list.