Transcript
Intro
Stephan Shipe:
Welcome back to the Scholar Advising Podcast. In today’s episode, we’re tackling three big money moves. First, we’ll look at what to do if a large portion of your net worth is tied up in company stock. Next, we’ll answer our question about 529s—specifically what to do when you’re close to fully funded and want to avoid overcontributing.
Finally, we’ll dive into a question from a couple weighing the decision of whether to buy abroad. And as always, we’ll wrap up with a rotating special segment. This week’s Term of the Day is a CRT—or Charitable Remainder Trust.
Let’s get started with Question 1.
Question 1: Diversifying Out of Company Stock with a 10b5-1 Plan
Listener:
I’m an exec at a large tech company with about 50% of my net worth in company stock. The stock has done very well, and I’m planning to retire in the next five years. Should I start diversifying with my 10b5-1 plan when the next trading window opens, even though I’m at a high tax rate? Or should I wait until my income drops in retirement to take advantage of a lower tax rate?
Stephan Shipe:
So this is a tough situation that you’re in, but a good one, right? You don’t get to a high concentration without really high returns. So you’ve likely had high appreciation, especially with the big tech focus there. We have to start looking at this from a risk perspective.
Now, it’s really easy—I could come up here and say, “Well, you shouldn’t have done that. You shouldn’t have put all of your eggs in one basket, 50%.” But you’ve gotten here for a reason—you had that high growth. So it’s hard to necessarily knock that. That’s been in the past. Now you’re stuck with high concentration.
It does lead to a high amount of risk. A lot of people don’t take into account how much risk a single stock actually has. When you look at the volatility of a single stock portfolio, you’re looking at a 40% to 50% standard deviation. That’s compared to a normal standard deviation or volatility in a diversified portfolio—closer to 19% or 20%.
So it’s a significant amount of risk, and that risk increase comes from what is known as the idiosyncratic portion of risk, which is the company-specific risk that you can diversify away from by adding other stocks to a portfolio. That’s the risk that the CEO makes a big decision the next day, or that the company is affected by any new type of regulation or lawsuit. That’s the kind of risk you’re currently holding in your portfolio.
So we know we want to start reducing that. The issue you have is you’re in a high tax bracket now. If you start taking a bunch of this off the table, you’re stuck with a high tax consequence.
To get rid of that, I think you need to do so in a structured way over the next few years and slowly divest. A 10b5-1 plan makes sense for that. The only issue with a 10b5-1 plan, especially if you haven’t done one before, is it’s not as easy as it sounds.
10b5-1 plans are ways for you to exit out of the stock without having to deal with any insider trading concerns. It’s systematic—you go in and say, “I’m going to sell X amount of shares this year,” so that everyone’s on the same page. You’re on the same page, the company is on the same page, and more importantly, shareholders are on the same page so that they know why an executive is selling stock. It’s not going to be construed as insider trading.
The only issue is, that’s not something you have full control over. It still requires company approval and must fall within timing windows. So it’s possible that you go in and say, “Hey, I would like to exit X amount of shares this year to reduce the risk,” and they come back and tell you no. That might be a direct no, or it might be a more subtle, “We don’t think that’s a good idea,” if you go out and start selling a bunch of stock—even if it is through this program.
So keep an eye out for that situation. You may go in and say, “You know what? I’ve thought about it. I need to reduce concentration. I want to go sell 10% of the 50% that I have in the portfolio,” and then go to get approval—and they say no.
So we’re going to have to plan for that contingency. If you can’t get rid of it now, then as soon as you retire, it’s going to make sense to reduce that holding. It may even make sense to consider your retirement date as a way to help reduce the risk component.
What I mean by that is, if you’re looking at retirement in the next five years, it could make sense to retire in two years or sooner—just for the benefit of having the lower tax bracket you would fall into, depending on what income you actually need in retirement.
So I would take into account the taxes, take into account that the 10b5-1 plan may be denied. The goal is in the right place—I think you really do need to start reducing the concentration here, whether it’s through selling it now if you’re able, or starting to give it to a DAF, or gifting it in other ways.
And let’s move on to our next question.
Question 2: Are Our Kids’ 529s Fully Funded?
Listener:
We’ve been putting $12,000 into each of our two kids’ 529s for a few years. The balance is now $90,000, and they have 7 to 9 years before college. I think we’re close to fully funded and don’t want to overfund. Should we start putting those contributions into a different kind of account?
Stephan Shipe:
So a couple things that we have to unpack here in your situation.
One is the 529 balance now versus what we’d expect it to be later. On average, you can expect a normal investment account to double in value every 10 years or so. Because it’s a 529 and the risk of those assets is going to decrease—you obviously don’t want a full stock portfolio two years before college starts—if the portfolio balance drops, you can’t delay college. You can’t tell your kids, “Hold off for a couple years until the portfolio bounces back.”
So what’s going to end up happening is, through their high school years, you’re likely going to see the risk of that account drop. So the returns will drop as well. But on average, if there’s $90,000 in there now, you’re probably looking at average returns—even if we’re at the 5% to 6% mark to account for the lower risk—that give you about 12 years for doubling. So $90,000 now, maybe you have $150,000 in the account at the time for college, depending on where they’re wanting to go to school.
Whether this is a public or private school choice, that probably gets you a lot of the way there. At $40,000 to $50,000 a year, that covers three or four years. You’d be able to add some cash flow in. So I would agree that you’re probably close to being funded in that case, and we don’t want to overfund the 529s.
It’s a restricted account. It typically doesn’t provide a ton of tax benefits from a contribution perspective unless you’re in a state that allows for state tax deductions. If that’s the case, then you could do some of that. But assuming that you’re fully funded, we don’t want to overfund.
If you ever do overfund it, there are options there—especially with the SECURE Act. There are new rules around being able to roll a 529 balance into a Roth IRA, which could be really beneficial if that’s something that you’re interested in for the kids. They still have to be eligible for a Roth IRA, but you could do $7,000 a year for five years.
There are other rules around it—like the account having to be open for 15 years—but there are some pathways that didn’t exist before if you overfund the account.
Now, if we assume the account is fully funded and we don’t have to worry about that, then the question is: you’re still putting $12,000 into an account—where else can you put it?
There are minor accounts—these UGMA or UTMA accounts—that you can start funding. Those are great options. One thing you have to watch out for: if you start funding these underage minor accounts, you’re going to lose control of that money as soon as they hit the age of majority. In most cases, that’s 18 for most states.
So let’s say you fund a UGMA account—a Uniform Gift to Minors account—and you put $12,000 into that account every year for your kids. They’re able to see this money grow, they have all these benefits, but they’re seven and nine. So now you’re going to have 10 years or so of growth. That account is going to be worth probably at least $150,000 to $200,000 by the time they get to the point where that account transfers directly to their ownership.
So if that’s the case, the question really comes down to: are you comfortable with your 18-year-old getting an account that’s worth $150,000-plus at 18, plus a fully funded 529?
I think that’s a good move, especially if gifting in the future is a goal. It’s an amount that is doable. It’s trackable. It’s a number they could see and get used to—especially if you start now. That would be the big change from the 529 to the UGMA: I would let them know that it exists and start getting them familiar with investing.
And the ages are perfect—especially as they start hitting 10, 11, 12—they start to have that kind of interest in money. You can start showing them the account growing. It’s not going to be a massive number that’s in there, so they’ll see $12,000 or $24,000 in the account that they can start helping you invest.
Good opportunity to start talking about things like: What are index funds? What’s the market? How does investing move up and down? And then when they get to the point of 18, they can take control of that account.
If you start to gift more than $12,000 to that account and really start hitting the maxes—say, $38,000—then I’d be more concerned. No matter how much you teach them, receiving $500,000-plus by the time they’re 18 is probably going to be a lot for them to take into account, and we’d want to start thinking about things like trusts.
But in your situation, I think you’re right—you’re probably fully funded. You need to start worrying about contributing that money to another account. A minors account is perfect, and a UGMA would be a great setup for it. I don’t think the amounts you’re contributing are anything that’s going to set them up for a massive, stressful event at 18 because of that amount.
Question 3: Buying a Vacation Home Abroad
Listener:
We’ve been spending winters in Cabo since 2020, renting the same place while working remotely. We finally priced out buying there, and even with property tax, maintenance, and utilities, it would pay for itself after a few more years. What else should we consider?
Stephan Shipe:
So it’s not uncommon that you find a vacation home, especially in a lower cost-of-living country, and the numbers work out. You look at it and say, we’re spending all this money to vacation there, to rent a place—so why don’t we just buy something?
The issue you’re going to run into—or things I would take into account—is there’s typically a big difference in what the lifestyle is going to be like staying somewhere that’s already set up for you, especially if you’re looking at more of a resort area, compared to a home that you’re going to buy.
The other factors are going to be things like your maintenance costs, insurance costs—everything that you would normally have for a vacation home in the States—except it’s going to be a lot more difficult.
So: can you call someone to do the maintenance on your house down in Mexico? Can you speak Spanish? Do you have somebody there? Because if not, the option is you’re going to have to pay a property management company down there—someone familiar with working with you and who knows professionals that can handle any maintenance needs or updates.
So it’s not impossible on the maintenance side; it’s just going to be an added cost because you’re likely going to have to bring in a third party.
The other side is insurance. As soon as you start looking at different countries, the insurance rules are completely different. If something breaks—if the house floods, or something catastrophic happens—the coverage aspects will be very different. The ability for you to file and collect on that coverage is going to be different, and the quality of coverage can vary quite a bit in different countries.
Now, the other aspect of this is the fact that you’re still working. So because you’re still working and wanting to stay there for an extended period of time, you want to make sure that you’re not going to run into any visa requirements or remote work issues—either with Mexico or the United States—where residency is going to be based from a tax perspective.
I would expect, assuming all is good—you say, fine, maintenance works, we have somebody down there who’s really good, who’s giving us a fair fee, we’ve already taken that into account, the cost of the home looks good, everything’s checking all the boxes despite me saying all this—then the last thing I would add in is that you’re likely going to have much lower liquidity and flexibility with the home.
Not only are you locking in a vacation home—which already reduces flexibility from a vacation standpoint—but assuming that you’ve said, “That’s the place we want to keep vacationing,” that’s fine. If the day ever comes that you no longer want to vacation there, or don’t use it as much, or want to switch homes or countries, you’re going to have a lot less liquidity. You’re not going to be able to sell the property as fast as you could sell one in the U.S., and you’ll likely take a hit.
So—not necessarily a knock on the whole plan—but there are additional impacts, especially around foreign ownership rules and estate tax implications. Foreign ownership concerns are going to be a big one that’s overarching.
Not only are you going to have your normal vacation home issues like we just talked about, but the foreign ownership is going to be a concern. What are the rules there? Are you allowed to own property? Are there conditions? Are you going to have to make investments? It’s very common for different countries to have rules that say, “Sure, you can own a property in our country as a foreigner, but we’re going to require that you make an investment of $500,000 into some public organization,” or “You’re going to have to make an investment in a business of $5 million at minimum before we allow you to buy a home in the area.”
All of those need to be taken into account, which means now you’re talking about foreign attorneys, CPAs who are familiar with foreign ownership and tax implications. So it’s not just the ownership cost—it’s the cost of all the other professionals that you’re going to have to bring in to help you with this transition and ownership, whether it’s the maintenance, the taxes, the attorney fees, or anything else.
Term of the Day: CRT (Charitable Remainder Trust)
Stephan Shipe:
And now we can jump into the term of the day.
So this is where we take on a complex financial planning term and break it down into plain English. This week we’re talking about CRTs, or Charitable Remainder Trusts.
The idea here is that you have an irrevocable trust. Typically, you take the money, you go throw it into another account, and it’s for somebody else’s benefit—it is no longer yours. So you don’t have control over it, you don’t have access to it, it’s not yours. You are able to gift it away.
One unique style of an irrevocable trust is a CRT. The way a Charitable Remainder Trust works is that you’re able to put assets into this trust and then pull only income out of the trust over its entire life, and the remainder ends up going to charity.
So basically you say, instead of a normal estate planning scenario that says, “Steph and I have $10 million, I’m gonna put it into an account. We plan on living off interest and using this throughout retirement, and whatever’s left is gonna go to my kids”—in this scenario, you throw a couple million dollars into this Charitable Remainder Trust, you’re able to use the interest or any type of income from this portfolio, and then at the end of your life, the remainder would go to charity.
What’s nice about that is that now you can put money into this Charitable Remainder Trust, take the tax deduction for it today—it’s going to a charity, so you get the charitable distribution for it—but any income that you get over it, you’re able to take out of the trust.
The way we see this used commonly, and the way we would use it, is: imagine a situation where you have a portfolio that maybe includes a few million dollars in a concentrated position in a stock—actually very similar to what we were talking about in the first question. So you have a concentrated position in stock. You don’t want to have to deal with the tax consequences of selling it right now. That’s going to be a mess.
But you could take, say, $3 million of it and put that into a Charitable Remainder Trust. You get the tax deduction for that contribution, and then you’re able to sell that stock immediately when it gets into the trust without the tax consequences. Diversify it now into, let’s say, a total market fund like the S&P 500, and then use income from the S&P 500 or from any gains throughout your life—as long as whatever the remainder is, is sent to the charity.
Now, there are some IRS tables and everything that require a certain amount be left to charity at the end, but that is a great way to: one, diversify away from a concentrated position; two, still get income from the assets that you have; and three, take a deduction today due to the charitable impact of it.
And if you’re charitably inclined, the remainder of it is going to go to the charity anyway—but you still get the benefit of income during that entire time.
So really neat structure, really neat trust to set up. Again, that’s the CRTs, or Charitable Remainder Trusts.
Closing
Stephan Shipe:
That’s all we have for today. Thanks for listening.
Hey, this is Stephan Shipe. Thanks for tuning in to the Scholar Advising Podcast. If you have a question you’d like us to tackle in a future episode, share it with us at scholarfinancialadvising.com/podcast. We’d love to hear from you. Until next time.
Disclosure
Scholar Advising is an independent, fee-only financial advisory firm focused on providing hourly financial advice. The information provided in this podcast is for general informational and educational purposes only, and is not intended to constitute financial, investment, or other professional advice.
The opinions expressed are those of the hosts and guests and do not necessarily reflect the views of any affiliated organizations. Investing in financial markets involves risk, including the potential loss of principal. Past performance is not indicative of future results. Before making any investment decisions, consult with a qualified financial advisor who can assess your situation, objectives, and risk tolerance. Thanks for listening!