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Swap Your Shares, Not Your Spouse

By Greg Hutto, CFP®, CFA®

It’s likely one of the biggest financial problems you have as an executive: concentrated stock. Your company grants you RSUs (restricted stock units) or stock options like candy, and that’s all well and good, but…you can’t always sell them at a moment’s notice, and diversifying outside of your employer’s stock is sometimes frowned upon.  

What you need is a way to sell your concentrated stock, invest the proceeds in a diversified stock portfolio, and minimize your single stock risk. But if you sell those big winners, you could get whacked with capital gains taxes, possibly as high as 20% depending on your income and the amount of your gains. (1) Is there any way to come out a winner? Keep reading to find out.

The Solution: A Swap Fund

A swap fund, or exchange fund, allows an investor with a sufficient net worth to swap his or her big holding in a single stock for units or shares in the entire holdings of the fund. And if performed correctly upon execution, no current taxation occurs since the investor is simply delaying taxation until the units of the fund are sold later when you retire or are in a lower tax bracket. 

How It Works

A swap fund is created when several investors pool their shares into a partnership. From that point, each investor receives a pro-rata share of the swap fund. Now the investor owns a share of a fund that contains a portfolio of different stocks, which allows for some diversification. But diversification isn’t the only point of a swap fund; it also allows for tax deferral. Because an investor swaps shares with the fund, no sale actually occurs. This allows the investor to defer the payment of capital gains tax until he or she sells the fund’s units.

The use of swap funds has been subject to some criticism. In the past, the SEC has investigated the use of swap funds for potential abuses from control persons. In particular, the issue drawing attention revolves around failure in disclosing one’s participation in a swap fund with stocks for which they are privy to sensitive market information. Consult your tax and/or legal advisors before entering into this or other transactions with potential tax benefits.

Types Of Swap Funds

Swap funds basically come in two varieties: private and public funds. A private swap fund, as the name would imply, involves companies that are not publicly traded, so that private equity holdings can be diversified. Public funds allow publicly traded stocks to be swapped.   

Participants will need varying levels of net worth to participate, depending upon the type of fund and its requirements. There is usually a lock-up period requirement in the range of seven years, so that tax deferral requirements are met. Typically, a small percentage of shares can be sold every year that fall outside of the lock-up requirement, in the 10% range.

Over time a public swap fund will tend to look somewhat like an S&P 500 fund, because hundreds of investors will contribute their shares, thus providing a diversified pool of typically large company stocks.  

Is A Swap Fund Right For Me? 

This stuff is complicated. Sound financial planning, investing, and tax management require specialized knowledge, skills, and experience. At Heritage Retirement Advisors, we specialize in corporate executives with their financial planning needs. We understand the financial complexities you face and are here to make sure your financial plan is airtight. If you have RSUs or other employee stock options, don’t hesitate to reach out to us to help you maximize these benefits and incorporate them into your overall financial picture. Call Don Brosious or Wes Holloway at 817-503-0100 or email them at info@heritage-retirement.com for a confidential discussion about your situation.  

About Greg

Greg Hutto, president and CEO of Heritage Retirement Advisors, comes from a family of educators, so it’s no wonder he holds a bachelor’s degree in business from Texas A&M University, and a master’s degree in education from Tarleton State University. He spent years as a teacher and coach before entering financial services in 1996. After 14 years in the industry working for such powerhouses as UBS Paine Webber and Raymond James, Greg founded Hutto Retirement Advisors LLC in 2010, now Heritage Retirement Advisors. He holds both the Certified Financial Planner® (CFP®) and Chartered Financial Analyst (CFA®) designations. Additionally, he is the founder of Heritage Tax Advisors LLC. Greg and his wife, Angie, have three children. He likes to cycle, play golf, travel with his family, and he’s still trying to convince Angie of his dream of being husband-and-wife truck drivers, or at least working and living on the road in an RV! To learn more about Greg, connect with him on LinkedIn.

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(1) https://www.irs.gov/taxtopics/tc409