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Plan Well, Retire Well

Saving and investing your money

Do you own your employer's stock in your 401(k)?


Unless you've been living under a rock for the last couple of weeks, you know that the stock market in the US has had huge ups and downs in response to news about companies failing, the US government bailout of FANNIE MAE and FREDDIE MAC, as well as insurer AIG. And now President Bush is pushing Congress to quickly pass a bill to bail out US financial markets.

How should you be reacting to this? My response to that question is usually this: "If you panic and sell your investments, you may be selling at the low point. When stocks move up again, you'll probably miss that rally and end up buying back in when prices have already moved up substantially. You're probably better off to just stay put."

BUT -

Do you own stock in the company you work for, either in your 401(k) plan or through an employee purchase plan? Do you have options, stock appreciation rights, or restricted stock units? Then I have one word for you: DIVERSIFICATION.

If you have most of your money invested in the same company you work for, you're in a very vulnerable position. Your livelihood and your net worth are tied to the future of one company. You might be very lucky, like my uncle. Maybe you'll become wealthy from the stock and earn a generous income until you choose to retire and live the good life. But maybe your company's stock will tank, you'll get laid off, and in a couple of months you'll be worried about losing your house or apartment.

You need to diversify. Most mutual funds won't put more than 5% of the fund's money in a single company. Many financial advisers suggest that their clients have no more than 10% of their money invested in any one company, particularly the one the client works for. What percent of your money is invested in your employer's stock? If it's more than 5 or 10%, you may be getting into dangerous territory.

I know, I know. You work for the company, you know how it's doing. My husband tells me the same thing about the company he works for. But that's what the employees of Enron, AIG, and other companies thought, too. They have learned the hard way that employees are often too optimistic about their employer's future.

Here are some ideas about how to reduce the amount of money you have invested in your employer's stock to an acceptable amount.

  • Before you sell anything, decide what kinds of investments will give you the diversification you need. That might be a mutual fund that invests in US stocks, bonds, or foreign stocks. Or maybe you need all three. For more on this, check the Choosing Investments section of our website, Plan Well, Retire Well.
  • You don't have to sell all your company stock at once. Whenever you move a large amount of money from one investment to another, it's often easiest to stomach if you do it bit by bit. You could sell a set number of shares of your company stock each month (or every two weeks, or every other month, whatever) over a period of time. Maybe it takes you a year, or even two or three, to sell all the shares you need to sell. Each time you sell company stock, invest the proceeds in an investment that gives you the diversification you need.
    • Note: If you owe brokerage fees each time you buy or sell, it will probably be cheaper to sell more shares at a time and do it less frequently. For example, you might sell 300 shares every other month instead of selling 75 shares every two weeks.
  • If you are selling shares at a profit, you will owe income tax on that profit - unless the shares in are a retirement plan. If you have shares inside your 401(k) plan and other shares that you bought through an employee purchase plan, stock options, or through a regular brokerage account, you'll need to decide which ones you should sell. If your tax preparer is knowledgable, he or she may be able to recommend the best strategy for your situation.
  • If you have an employee stock purchase plan that lets you buy company shares at a discount to the street price, you may want to continue participating in that plan. But you should set up a schedule to also sell shares periodically, so that you don't get too heavilly invested in your company's stock again. If you sell shares at a loss, you will need to schedule the sale of shares to be more than 31 days before or after the purchase date of new shares. Otherwise, you'll be subject to the wash sale rule, which will prevent you from deducting those losses on your income taxes.
  • Understand how any profits on the sale of your stock will be taxed. The rules for stock options and employee purchase plans are more complicated than the rules for shares you bought through a broker. Two good sources are IRS Publication 525, and MyStockOptions.com.
  • If you leave the company or retire with company stock inside your 401(K) plan and roll that over to an IRA, you may have a one-time opportunity to transfer that stock to a regular brokerage account so that it will qualify for the lower capital gains taxes (maximum 15%) when you finally sell it. If you transfer the stock to the IRA, you'll owe income taxes at the regular income tax rate (as much as 28% or higher) when you sell and take the money out.

This is a very quick and dirty overview of the risks of having much of your net worth tied up in one company, and a rough outline of some of the strategies and issues with selling that stock so you can diversify. Please take the time to read up on these issues, and consult with a qualified financial planner or tax professional before taking action.

Do you have tips, stories, or warnings to add to this? Click on my name below and send them to me. I'll include the best ones in a future post.



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