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By Holly SwanExecutive Director, Advisor Institute

As you know, likely all too well, there are times when an existing or prospective client's preconceived thoughts about their company stock prevent them from recognizing the value of diversification. Instead of diving right in to the tactical merits of diversification, which may cause them to become defensive, what if you took a different approach?

Invite them to have a discussion about their thoughts on the concentrated position by using words and phrases that set a collaborative tone such as, "are you open to." An ism can also provide some perspective, as it is an evergreen belief that frames your philosophy and connects the dots to the recommendation you are making.  

Consider a CFO of a public company who plans to work for three more years and then retire—the success of his plan hinges largely on the performance of the company stock he holds within his taxable portfolio. When a concentration of incentive compensation is a concern, here's how the phrase "are you open to" and the ism "not all shares are created equal" can move the conversation forward:

Advisor: "The equity you've built working for Company ABC is quite impressive. Are you open to discussing how your concentrated positon could impact your ability to achieve your primary goal of retiring in three years?"

Client: "My company stock has performed really well over the last few years, and I feel confident that it will continue to do so. Besides, aren't there tax advantages to holding it?"

Advisor: "Not all shares are created equal. Equity in your employer belongs to multiple tax buckets rather than being its own bucket. Some types of employer stock are more favorable to hold, while others are more favorable to consider diversifying out of sooner."

By approaching the conversation in this way, you can help clients and prospects understand the optimal time to consider diversifying concentrated shares. 

  • Vested restricted stock units (RSUs). Think of an RSU as cash compensation paid in the form of equity. Subject to insider trading rules, vested stock can be sold immediately upon vesting in order to diversify. For positions not sold upon vesting, capital gains consequences should be factored in to the decision to sell. Vested shares with built-in gains can also be used to fund charitable giving.
  • Vested in-the-money incentive stock options (ISOs). Shares acquired through the exercise of ISOs are attractive in taxable accounts because in a qualifying disposition, the entire difference between market value and discounted purchase price is taxed as long-term capital gains. Beware of the possible alternative minimum tax (AMT) consequences of holding these beyond the year of exercise.
  • Vested in-the-money nonqualified stock options (NQSOs). Unlike ISOs, there is no tax benefit to holding shares acquired through the exercise of NQSOs. NQSOs let the holder control the timing of the taxable event, and ordinary income tax on the full bargain element is triggered upon exercise, which has the effect of shrinking the discount received on the stock. A cashless exercise of NQSOs and a subsequent contribution can be used to fund charitable giving.
  • 401(k) plans. Employer stock in a 401(k) can be subject to favorable tax treatment, referred to as net unrealized appreciation, so there can be benefits to continuing holding these shares.

Bottom line: Keep in mind that the same employer stock concentration you're hoping they will diversify away from is likely what created the wealth that brought them to the table with you in the first place.