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6 Strategies to Diversify Stock Compensation or Options

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Managing your stock compensation or options to mitigate high tax impact requires strategic planning and careful consideration.

Author: Martin Lundgren

If you work for a company about to go public, you may be looking at a significant stock compensation package. Woohoo! This is undoubtedly an exciting opportunity; it’s is, however, essential to consider the potential tax implications that come with it. 

In this article, we’ll explore several strategies to help you diversify your stock compensation while minimizing the tax burden.

1. Options Collar Strategy 

One approach to protect your stock position while generating income and managing risk is through an options collar. This strategy involves simultaneously purchasing protective put options and writing covered call options against your stock holdings. The protective puts provide downside protection, limiting potential losses. At the same time, the covered calls generate income, offsetting some of the taxes incurred upon exercise. 

By establishing a trading range within which your stock can fluctuate, you can manage risk and potentially reduce tax exposure. Investopedia further breaks it down here if you’d like to learn more.

2. Buy Put Options 

While purchasing put options can be expensive, they offer a straightforward way to hedge against downside risk without selling your stock outright. Put options give you the right to sell your shares at a predetermined price within a specified time frame. This provides downside protection in a market downturn.

Take note: buyers and sellers have competing interests when it comes to options. Though this strategy doesn’t directly address tax implications, it can be valuable in managing overall portfolio risk.

3. Exchange Funds 

Exchanging funds within your stock compensation plan can be a tempting option to defer taxes and diversify your holdings. However, it’s essential to consider the long-term implications carefully. Exchanging funds may provide temporary relief from immediate tax obligations. However, it merely kicks the can down the road. And, it may not effectively diversify your portfolio. Before pursuing this strategy, evaluate the potential impact on your overall financial goals.

4. Direct Indexing with Tax Loss Harvesting 

You may have read our recent post on direct indexing. Our team believes it can be a powerful tool for a personalized and tax-efficient approach to wealth management. That’s because direct indexing offers a more sophisticated approach to managing your stock compensation while minimizing tax impact. 

By replicating an index using individual stocks, direct indexing allows for greater flexibility in tax management, including tax loss harvesting. This strategy involves strategically selling securities at a loss to offset capital gains and reduce taxable income. While the tax benefits of direct indexing are significant, remember to weigh the potential risks and costs associated with this approach. And, of course, speak with a trusted advisor.

5. Sell Call Options

Selling call options against your stock holdings can provide additional income while potentially mitigating downside risk. However, this strategy comes with its own set of trade-offs. By selling call options, you’re effectively capping your upside potential. Also, you expose yourself to the risk of having your shares called away if the stock price rises above the strike price. Keep in mind that though this approach can generate income, it may not be suitable for investors seeking to fully diversify their holdings.

6. Simply Sell it All and Pay the Tax 

Sometimes, the simplest solution is the best. Selling all your stock holdings and paying the associated taxes upfront allows you to diversify your portfolio immediately. It also helps you potentially avoid future tax headaches. This approach may seem straightforward, but it’s essential to consider the tax implications carefully. Don’t forget to consult with your financial advisor to ensure it aligns with your overall financial plan.

Discuss your options with your financial planner or advisor

Managing stock compensation or options with a high tax impact requires careful planning and consideration of various strategies. Whether you choose to implement an options collar, buy put options, exchange funds, sell it all, or explore more sophisticated approaches like direct indexing, it’s essential to align your strategy with your overall financial goals and risk tolerance. 

Consulting with a qualified financial advisor can help you navigate these decisions and develop a tailored plan that meets your needs. By diversifying your stock compensation strategically, you can mitigate tax impact. Additionally, careful planning helps position yourself for long-term financial success.

If your company is about to go public, the team at Northern Lights Advisors can provide valuable insights and guidance tailored to your specific stock compensation package. Reach out today 

Northern Lights Advisors provides financial planning and wealth management services as a fiduciary, fee-only, Registered Investment Advisor (RIA) firm based in Seattle, Washington. The information in this article is not intended as tax, accounting, or legal advice. Read the full disclaimer here.