This story was written and paid for by Mindful Money, a Berkeley wealth management company that is committed to a behavioral and mindful approach towards financial wellbeing.
The Bay Area experienced another boom of initial public offerings (IPOs) in 2020 — and it looks likely to continue into 2021. With giants like Snowflake and Airbnb (among many others) having recently gone public, a whole new crop of millionaires is sprouting in the Bay Area.
If you are one of the lucky about-to-be millionaires, there are many things you should consider and some things that you should do. If you plan appropriately, you can save on taxes when you sell your stock and accomplish other good things, both for yourself and society, at the same time.
Contemplating a windfall is a good time to reevaluate where you are in your life, think about your values, and where you want to go from here. You will have to evaluate the natural tendency to go for more: more house, more car, more vacation, etc. Will you continue working at what you are doing, or will you think about doing something else?
Sure, you should celebrate: maybe buy that car you have had your eye on, or some other thing. But if your projected haul is sizeable enough to go beyond a little spending spree, then you should plan to plan. You should maintain your equilibrium (not always easy in the face of new-found riches) and take time to think about what you want to do before you execute.
Accommodating yourself to wealth is a visceral, experiential process.
To begin, think about building a team of advisors if you do not already have one: a CPA knowledgeable with issues surrounding restricted stock and whose practice is built around clients who are high earners with valuable assets; an experienced estate-planning/tax attorney and a financial planner/wealth manager. If you are lucky enough to have this windfall in your 20s or early 30s, you might think that you do not need an estate planner. But consider this, if you die without an estate plan, your wealth will have to pass through the probate system, expensive and time-consuming and needless trouble for your heirs. With new wealth comes new responsibilities, and one of them is risk management.
We have worked with hundreds of people in your position over the last 25 years. Here is a brief review of a four-part plan.
1. Snap back to reality before you spend
First, just because you are about to go through an IPO or just did with a big pop in the stock price the first week does not mean that your pre-IPO stock will win the lottery. Most new millionaires-on-paper are still subject to a six-month lock-up. Even when that period is over, you will remain subjected to limited selling windows, so be careful if you are making plans based on sky-high stock values. The money is not real until the stock is sold and the cash proceeds are in your account.
You must think about what kind of options and/or restricted stock you have. Incentive Stock Options (ISO) and Non-qualified (NSO) options and restricted stock are taxed differently, and each requires some decision-making and strategy. If you do consider selling some of your position immediately, make sure to plan for the taxes that will result from your sales. Depending on what you have and how you handle it, the tax can be classified as ordinary income or capital gains, the latter being a lower amount.
If you go ahead with a sale, how much money will you have after taxes? What is the purpose of the liquidation? Is it a gift to yourself for an immediate purpose? Is it for risk management by diversifying some of your concentrated position? Do you have enough to change your life or is it a good foundation or addition to a long-term fund you have already started?
As we suggested above, a good first step in preparation for an IPO is to put a team in place, one you choose and respect for their knowledge and experience but also a team whose members you feel comfortable with. Engaging a planner and crafting a plan is a must do and it takes some time. So build the team while you craft your plan so that you get to know them, and they get to know one another. If you want the most of, and from your wealth, treat it the same way you would a business. The team is the primary step in starting to steward your wealth.
Do you view this money to come as your windfall, or is it something to share with family and, perhaps, the larger community also? If it is the latter, we are talking to you.
2. Remember your core values and your heart’s goals
The sources of success are many. Hopefully, you had parents who loved you. Maybe you had a great education. Maybe one of your professors encouraged you. Maybe you came to the Bay Area intentionally… or maybe you followed your college girl/boyfriend? You worked hard and you struggled but there is no denying that luck played a hand as well, even a large hand.
For every company that goes public, there are hundreds of others that either stumble along in the attempt or fail entirely. The list of companies in the Bay Area that were once destined for greatness and are now no longer around is incredibly long. This is a reason to be grateful.
Gratefulness may or may not have been something you were taught but it is certainly a value to embrace now. When you are newly wealthy in a place like the Bay Area in a time like 2021, you have to remember, and reaffirm, your values. Consider what is really important to you as humans. How do you fit into the bigger scheme of life in our community?…on this planet? What is your vision for this life? What drives you? Do you have a purpose?
Recalling your values, writing them as you would the core values of an enterprise, will add enormously to your clarity about your wealth, your place in the community, and to your long-term well-being and enjoyment.
If you need help with values and personal goals, we have created a free course for you: Mindful Money – Purpose & Goals.
3. Practical steps to establish your secure foundation
Once you can exercise your options and begin selling your stock, you will be faced with decisions. The stock in your company may be the largest asset you have and may be your most concentrated asset. You will have two immediate concerns: the tax on your sales and the need to manage your risk because having so much of your wealth in one asset is dangerous in that your company could have a bad quarter or a bad year and a significant drop in the stock is likewise a significant drop in your wealth.
Maybe you do not have quite enough shares to cover your entire income for life. Maybe you need to make a down payment on your first house or on a renovation. Maybe you have your child’s educations to plan for and to pay. These are all important and can all be part of your Mindful Wealth Map.
There are some very effective techniques to deal with concentrated positions of securities and the tax implications of selling. One of them, which we will not discuss in depth, is called a variable forward sale. The variable forward sale is a mechanism to liberate some of the value of your stock and defer taxation. In combination with a tax-managed index portfolio, it is a means to diversify your holdings and thereby diminish risk and to defer and then reduce your taxable amount once sales are recognized. This is one example of a strategy we employ in our practice.
If you have a significant enough position, you may want to use part or all of your position to create an income stream that will be sufficient to fund your lifestyle, now or, if you choose to continue working, when you retire. There are many ways to accomplish this and we are going to discuss one that has the benefit of engaging your values because it has a charitable component. It is called a Charitable Remainder Trust (CRT).
A Charitable Remainder Trust is a split-interest trust, generating an annual income to its income beneficiaries and, after the death of the income beneficiaries, going to a charity or charities, depending on the wishes of the person or persons who created the trust.
A CRT is usually funded with appreciated assets, and in this case, we are talking about stock with a low cost-basis. The trust has several tax benefits: first, by donating the stock to the trust, the donor will receive an income tax deduction pegged to the market value of the stock and able to be utilized in the year of the gift and for up to five years afterward until it is fully used. The size of the deduction will be determined by the amount of the annual payment, denoted as a percentage of the value of the trust, and the duration of the trust, an actuarial calculation based upon the life expectancy of the income beneficiary(ies). The annual draw must be at least 5% and can go higher subject to several rules. A trust can also be limited in time, with a minimum of twenty (20) years. And a CRT can also be constructed to begin annual payouts at a later date, such as retirement.
For a fuller definition of a CRT, its types and other issues you can use these links to begin your own investigation:
To recap, here are the steps to creating and operating a CRT that creates a sufficient income stream to replace your salary:
- With an attorney, you establish the trust.
- Contribute enough shares to cover your annual income (roughly annual income need x 20). For example, if you need $100,000 / year to ‘retire’ today, then you would deposit $2,000,000 into the CRT.
- Receive a large tax deduction that is applied against ordinary income and against the capital gains that would be generated by the sale of other shares outside the CRT.
- Sell the shares inside the CRT (avoiding capital gains).
- Invest the proceeds in a diversified portfolio that will be expected to grow at a rate sufficient to generate each year’s payout and to keep up with and hopefully surpass inflation.
- Pull 5% from the portfolio every year which can be paid quarterly or even monthly (this is your lifetime income foundation).
- At your death, or your spouses’ if you are both income beneficiaries, the “remainder” goes to the charity of your choice. The choice of charity(ies) can be made at the time the trust is established or it can be made later, and it can be changed (if the trust is written to enable that).
One regret we have heard repeatedly is that people wish they had diversified their portfolio earlier, removing their concentrated risk, and had focused on creating the income stream they cannot outlive.
Combining a significant tax advantages with a broadly diversified portfolio can give you a secure foundation for life. In addition, it can be an opportunity to involve yourself and your family in charitable activities during your lifetime and to make sure that the charities you first choose are the right ones to support after your death(s).
4. Develop your empathy and compassion
When people become wealthy, they tend to rely less on others for their basic needs and become more self-focused. As their lives become more abundant, money becomes a shield. Their time and energy are no longer occupied with many of the challenges that face normal, i.e. middle class or lower on the economic scale, people on a normal day. Wealth, it is sad to say, can have the effect of making people less ethical, more selfish, more self-absorbed and less compassionate, according to the work of Berkeley psychologists Paul Piff and Dacher Keltner.
There is a risk, perhaps even a probability, that more wealth correlates with less concern for others.
Combat this tendency. We suggest adopting the model of the “stealth-wealth” community, a lower key, more humble and purpose-oriented group of people. Determine where you want to be 20 years from now and mindfully use your nest egg to take steps in that direction.
Even today, being a millionaire is a rarity. According to the Federal Reserves 2019 Survey of Consumer Finances, only about 12% of Americans are millionaires. If you are a millionaire under 30, even in your 30s, then you are far more successful than your peers. If you are a millionaire AT ANY AGE, you have done well. But do not let your wealth wall off your world. Keep your eyes and your spirit open.
If possible, turn that success into something more significant than individual achievement, as satisfying as that is. Your wealth can be a spectacular tool to improve the world around you. Likewise, it can enable you to expand your world as you invest yourself into a cause and community larger than yourself. Research proves that simply buying someone else’s meal brings a lot more sustained happiness than taking yourself out to a fancy dinner.
Congratulations on your company’s successful public offering. You can and should be happy and proud of the accomplishments your team has made. Remember though that financial success does not translate into happiness and well-being without vision, intention and work.
Money is nice, but life success depends on your declaring and sustaining your core values. We hope you find these thoughts helpful and impact our world for the better.
David Glotzer is a Wealth Advisor at DeYoe Wealth Management, Inc dba Mindful Money, a Registered Investment Advisor. He has two decades of experience in the financial and trust worlds.
Jonathan K. DeYoe is President of DeYoe Wealth Management, Inc dba Mindful Money, a Registered Investment Advisor. He is the author Mindful Money: Simple Practices for Reaching Your Financial Goals and Increasing Your Happiness Dividend.
This material is solely for informational purposes. Advisory services are only offered to clients or prospective clients where DeYoe Wealth Management, Inc. dba Mindful Money and its representatives are properly licensed or exempt from licensure. Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital. No advice may be rendered by DeYoe Wealth Management, Inc. dba Mindful Money unless a client service agreement is in place. Mindful Money is a service mark of DeYoe Wealth Management, Inc. a Registered Investment Adviser.