How to protect my nest egg without losing my shirt?
March 23, 2007 12:38 PM   Subscribe

Tax question: Is it better to diversify (and pay a lot of taxes) all at once, or to spread it out over a few years?

When I was born, my grandparents gave me some AT&T stock. Fast-forward 35 years, and the stock has split, spun-off, re-consolidated, etc., and grown a whole lot. In fact, it now accounts for about half of my total net worth. I know that's not a good thing, and I need to put my eggs into many more baskets. Unfortunately, that will mean selling a big chunk of the AT&T, and paying a lot of taxes on it. My question is whether it would be better to do that all at once, and get the pain over with, or if there would be some benefit to doing it a little at a time over a few years. I'm sure that depends on many different details of my specific situation, but I was wondering whether there was any common wisdom or advice about this sort of thing. Thanks for any help!
posted by svenx to Work & Money (15 answers total)
What country are you in?
posted by acoutu at 1:01 PM on March 23, 2007

Haven't the Democrats talked about rolling back some of Bush's tax cuts? If that happened, you might see the capital gains rate increase.
posted by dcjd at 1:23 PM on March 23, 2007

Best answer: Assuming that your AGI takes you over the 15% tax bracket, the long term capital gains rate is 15% of your profit. It is due in the year when you sell the security. It really doesn't matter if you sell it all now or half now and half next year, you'd owe the same net tax.

The only thing that could mess you up is that the current long term capital gains rate of 15% is only certain to last until 2010, when it will revert back to the old rules 18% or 20%. However, they may well extend it again -- they have already done so once.

If it is a really large sum of money, there could some options to put it into trust accounts, especially if you had kids' college expenses to plan for.
posted by Lame_username at 1:31 PM on March 23, 2007

Ignoring the tax aspect of it, you might want to spread out your sell dates a bit just to reduce the risk of selling it all at what you later find out to be a bad price. If AT&T stock skyrockets next week, you'd kick yourself for selling it all before that.
posted by stilly at 1:42 PM on March 23, 2007

Response by poster: Thanks for the input so far! (I'm in the US, btw).

Lame_username: My first child's due this August -- is there anywhere particular I should look for information about possible trust accounts?
posted by svenx at 1:42 PM on March 23, 2007

stilly- I'm not sure I buy the logic of that. You're simply making a guess based on whether you think AT&T will go up or down. If you sell and it goes down, it turns out you made a smart move. If you spread out your selling and it goes down, you're riding the drop and losing (theoretical) gains.
posted by mkultra at 1:55 PM on March 23, 2007

svenx, regarding your child: Google "529 plans".
posted by yclipse at 2:08 PM on March 23, 2007

If you spread out your selling and it goes down, you're riding the drop and losing (theoretical) gains.

But your losses are less than if you had held onto all of it, thinking the stock would rise, and sold it at a later date.

The point behind spreading out the sell dates is not maximizing one's return (if that were all there were, you would be correct: selling in several chunks is no better, on average, than selling all at once, and may even be slightly worse due to broker's fees); the point of spreading out the sell dates is to reduce one's risk.
posted by DevilsAdvocate at 2:21 PM on March 23, 2007

the point of spreading out the sell dates is to reduce one's risk.

There was a paper, long ago, in the FAJ that found that averaging strategies like this actually increased the variance of returns, rather than decreasing it, which, I admit, seems counterintuitive and wrong. And I can't find the cite, so take what I say with a grain of salt.

That being said, if svenx is merely going to redeploy the assets into other common shares, I don't think the firm-specific risk of AT&T is substantial enough to warrant a lot of hand-wringing either way. AT&T's business model and competitive position are pretty widely understood by the market, and unless regulators decide to give incumbent telco shareholders an unexpected present, I wouldn't anticipate getting much alpha (that is, excess return relative to the market) out of the shares.

And, last I checked, there isn't really a way (trust or no trust) to contribute securities to an investment account such as a 529 plan and avoid taxes on the eventual sale of the gain. In other words, you, your kid, the trust, whomever will be paying taxres on the capital gains, and the only way of deferring these gains is not to sell. Or using some sort of fancy short-against-the-box-constructive-sales loophole strategy, which isn't really going to work out for you unless you are dealing with tons and tons of money to pay for advisors, and even then, probably not.
posted by Kwantsar at 3:05 PM on March 23, 2007

And, last I checked, there isn't really a way (trust or no trust) to contribute securities to an investment account such as a 529 plan and avoid taxes on the eventual sale of the gain. In other words, you, your kid, the trust, whomever will be paying taxres on the capital gains, and the only way of deferring these gains is not to sell.
If the tax is paid by the kid, he/she will have presumably zero income and will pay no tax on the first 33k of gains (or thereabouts) each year. I'm not an expert on this and I'm somewhat drunk, but I think it would be possible to transfer income to the kid. What I'm not sure is if the kid's basis is the value of the stock at the time of transfer or not. I'm way over my head here, but I know that you can give stock to charity and avoid paying the cap gains. At first blush, I would think gifting it to a trust might have the same effect.

There has to be someone smarter than I on mefi who can provide a better answer.
posted by Lame_username at 5:03 PM on March 23, 2007

If by "529 plan" you mean a section 529 qualified tuition program, then I'm pretty sure you can only contribute cash. I say that because section 529(b)(2) says "contributions may only be made in cash," but it's possible I'm missing some nuance.

If you give the stock to your kid, transfer the stock to a trust of which your kid is a beneficiary, or convey a beneficial interest in the stock to your kid in any other way as a gift, your kid's basis in the stock will be the same as yours. As your kid or the trust sells the stock, it will have capital gain just as you would've.

Even worse, there's the gift tax. I don't really know the gift tax, but I'm pretty sure that giving your kid a big chunk of valuable stock is covered.
posted by Mr. President Dr. Steve Elvis America at 11:25 PM on March 23, 2007

Gift tax is $12,000 per individual per year. Check with an acct., but you may be able to give $24,000 per year if you and your spouse both gift your child. You need to do a tax projection before you sell to make sure the stock sale doesn't bump you up into a higher tax bracket. Unless we are not talking about very much stock the best strategy is to sell a little bit each year. The exception to this would be if you have a loss to offset the gain, or if you anticipate a future increase in income to the point where you are going to jump tax brackets. If this is a significant amount of money, you should really talk to a CPA, and/or a Financial Planner. I recommend the CPA first, as their ethics restrict them from trying to sell you securities, etc...
posted by BrotherCaine at 5:06 AM on March 24, 2007

Sorry, amend above to say gift tax kicks in after the first $12,000 in a given year. I'm tired.
posted by BrotherCaine at 5:07 AM on March 24, 2007

Best answer: My first recommendation is that if it's a large amount, that you take the time and minimal expense to chat w/ a CPA about this.

Now for some random points...

Like others have mentioned, the 15% long-term capital gains rate isn't really that onerous (and may or may not go back up in the future).

The thing you'll want to watch out for is whether (b/c the sales count as income) your transaction could trigger the AMT. That could cause a lot of headaches depending on what you normally deduct and that's what I'd watch out for.

Like others have mentioned, between 2008-2010, TIPRA rules state that there are no capital gains taxes for individuals with $30,650 or less in income. So you can gift those stocks to to your kid and and as long as those assets are sold between 2008-2010, you can make out w/ that amount untaxed.

A 529 probably doesn't really help you since you'd still have to sell the stock... but there are some gift provisions for making lump sum contributions (60-120K) where you can use 5 years of the gift tax at one time.

529 are for "education only" but once in there the money is tax advantaged so that at the very least will mean that you don't need to worry about your kids college. If you don't need
the money in the next 10-20 years, you should run the numbers because you may do better putting your account in that or an IRA even if you end up doing an early withdrawal and paying the penalties (usually = income tax + 10% penalty - the reason it's usually worthwhile is that the entire time you're growing w/o an CGT drag on your investments, usually 1-2% compounded annually w/ most funds).
posted by lhl at 12:02 PM on March 24, 2007

I stand corrected on the transfer-the-shares-to-a-custodial-account trick, but note the following:

1. The money in the account must be used for the child's benefit, and the child gets complete control of the account when he reaches the age of majority.
2. I'm not sure that TIPRA is being interpreted correctly here, as it contains a provision to beef up the kiddie tax.

Also, the gift tax isn't really a gift tax in any meaningful sense. It's just a way to make sure people don't do an end-run around the estate tax, and probably isn't a concern for svenx unless s/he will be a millionaire.
posted by Kwantsar at 1:19 PM on March 24, 2007

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