Show Notes

• (01:00) How to Handle Stock Acquisition of a Company Held in My IRA? (Hubby & Me from Tennessee – Cyd)
• (04:43) Why Shouldn’t a Trust Be Your Retirement Account Beneficiary? (Fish Sean Woo, Winter Springs, FL)
• (11:24) Are These Good Reasons to Transfer Out of the TSP at Retirement? (Cass, Mississippi)
• (18:12) Did I Pay Too Much Alternative Minimum Tax (AMT)? (Cindy, North San Diego County)
• (24:48) We’re Retiring Next Year. Should We Make Only Roth Contributions? (Ken, Fremont)5
• (31:38) The Best Way to Contribute to a Health Savings Account (HSA)? (Tyler, NJ)
• (36:14) Should I Sell Restricted Stock Units (RSU) for Long Term Capital Gains or Short Term Capital Gains? (Mike, DC)

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Transcript

Today on Your Money, Your Wealth® podcast 363, you’ve heard Joe say not to make your trust the beneficiary of your retirement account, today he’ll explain why. Plus, are withdrawal restrictions and required minimum distributions good reasons to transfer out of the thrift savings plan or TSP at retirement? Big Al explains how alternative minimum tax or AMT works, and the fellas discuss strategies for health savings account or HSA contributions and restricted stock units or RSUs. HSA, AMT, TSP and RSU? It’s a nice healthy acronym salad to celebrate Joe’s recovery from COVID! Visit YourMoneyYourWealth.com and click Ask Joe and Big Al On Air to send in your money questions as an email or a priority voice message. We’ll kick it off with how to handle stock acquisition of a company you hold in your retirement account. I’m producer Andi Last, with the hosts of Your Money, Your Wealth®, Joe Anderson, CFP® and Big Al Clopine, CPA.

How to Handle Stock Acquisition of a Company Held in My IRA? (Hubby & Me from Tennessee – Cyd)

Al: We did. Happy Holidays, and all that stuff.

Joe: The holidays are done and over.

Al: I know and I was in Maui after that, volunteering at the Kapalua Golf Tournament, which was awesome. Loved it. I’ll do it next year.

Joe: I was in a basement in Arkansas with COVID. Great times.

Al: You’re good now, right?

Joe: I’m totally fine. Negative. This thing lingers, though.

Al: That’s what I’ve heard.

Joe: I feel fine. It’s just a little lingery. So I’m going to have a really cool radio voice.

Al: This is what we’ve been dreaming about.

Andi: Nice and deep and snotty. Just what you need.

Joe: Really needed COVID to take me over the edge.

Al: This will be our best show ever.

Joe: Andi, let’s see. What do we got on deck here?

(voice recording) “Hello, Al, Andi and Joe. Happy holidays. This is Hubby and Me from Tennessee. I have a question about the stock acquisition that’s in my IRA. I own stock in Company A and it’s held in my IRA account with Fidelity. The acquisition of Company A is in negotiation with Company B expecting to occur in 2022. Company B intends to make a tender offer for $95 per share for a company which has been trading around $80 per share. Company B wants outstanding shares for Company A to be retired. How do I handle this? How do I make sure I get contacted by Fidelity about this tender offer? I should get the Company B share equivalent of 21%, assuming the exchange at $95 goes from what it’s currently trading at. Since this is in my IRA, there should be no taxable impact until I sell the new Company B stock and then the money will be received and taxed as ordinary income. Please advise and confirm. And as always, thanks again for your help. Owning two rescue mutts and driving a 2018 Santa Fe.”

Joe: Hubby and Me from Tennessee.

Andi: She has actually emailed us multiple times before, and this is the first time that she’s called in. And one time she actually said Hubby and Me from Tennessee, and you just ran with it Joe, that became her name. So she stuck with it.

Al: OK. Thanks for reminding us. So Company A is buying Company B, that happens all the time. So this would be an acquisition by Company A buying Company B, and it would be common in a public company for a Company A to have to offer more than the current share price, that’s how they get the whole company to be able to do this. So the good news is this will all be handled. You’ll get the paperwork, being the owner of the IRA, you’ll sign the paperwork. Fidelity will get what they need because it’ll happen naturally.

Joe: These are public companies, I’m assuming.

Al: You would think so.

Joe: It’s held at Fidelity.

Al: It would have to be a public company. So I think as long as you sign the paperwork that you get from Company B to buy out Company A, it should happen automatically in your IRA. I don’t think there’s anything more you have to do.

Joe: I wouldn’t overthink it. I would just keep an eye on it whenever the transaction happens.

Al: Company B is not going to want any Company A shares outstanding, so they’ll track it down. You’ll have to send them the statements, they’ll know it’s in your IRA. So I think it’s just whatever paperwork you get to sign and whatever they ask you for, like statements, send it to them, and that should happen naturally.

Why Shouldn’t a Trust Be Your Retirement Account Beneficiary? (Fish Sean Woo, Winter Springs, FL)

Joe: Fish Sean Woo. We have the coolest listeners in the world. The reason why it’s a bad idea to name a trust as the beneficiary of a retirement account is because most people do not have the appropriate trust set up. And secondly, with the elimination of the stretch IRA, it doesn’t really protect the money because everything has to be distributed out in 10 years. So a few things. Here’s the rules. If you name a trust a beneficiary of a retirement account, there’s basically a few things that have to happen. Because a trust is an entity, it doesn’t have life expectancy. So let’s say that Fish Sean Woo names his children or grandchildren or nephews, nieces, friends or whatever. They have to be identifiable. They have to be people as the beneficiary. But he also has, maybe 5% of the beneficiary of this trust to the African fish society. It messes it up, because every beneficiary needs to be identifiable. Prior to the SECURE Act that eliminated the stretch IRA, you could stretch out the life expectancy, or you could stretch the tax out of a retirement account over the life expectancy of the beneficiary. And people would set up subset trusts because they would take the life expectancy of the oldest beneficiary and then they would go into smaller trusts and things like that. The Supreme Court a few years ago also identified retirement accounts that are a beneficiary account would be subject to bankruptcy and things like that because it was the deceased’s property. It’s not the beneficiary’s property. So people would want to set up a trust there to protect it against certain creditors and things like that. So if you set up a trust appropriately, it made a lot of sense, but it had to be a see-through or look-through trust. So it would have to look through the trust itself and look at the beneficiaries and identify the people that are the beneficiaries of the trust.

Al: So to recap, all beneficiaries need to be people. Otherwise, it screws this whole thing up.

Joe: Second, is that it’s got to be a legal document. No big deal. Third is that there’s a delivery requirement, so the trust documents need to go to your custodian, such as Fidelity or Vanguard, TD Ameritrade, Charles Schwab. And so there’s issues there because it’s an entity, it’s not a person. So before you would just name a person and the stretch IRA would automatically happen. Everything would be fine. The trust would kind of blow up the stretch. So, I could get really in the weeds here, depending on if it’s a discretionary trust, if you’re going to hold cash in trust or not. The short answer here, Fish Sean Woo, is that if you want to control the money from the grave, then you would want to set up a trust. So you don’t trust your beneficiaries. You’re like, Big Al, you’re my beneficiary. I don’t trust you with the money.

Al: Yeah, I’m going to spend it all in the first year.

Joe: Correct, so I’m going to hold it in a trust, and I’m going to just give you a couple of bucks each year. So that’s the only reason why you would want to set up a trust today. But the problem with that strategy is that you’re holding the money in a trust and distributing it out, let’s say, over 30 years. But because of the elimination of the stretch IRA, all of the money gets out of the retirement account within 10 years. But it’s still held in trust, and now you’re going to be taxed at trust rates if you hold it in trust, which the top rate of 39.6% is somewhere of $11,000 of income.

Al: Yeah. 37%. But it hits $12,000, $13,000 of income. So it basically has higher tax rates. And in some ways, you could say with the elimination of the stretch, maybe it doesn’t matter as much, but you hit the nail on the head. The trust tax rates, if you’re going to hold these RMDs in the trust, they’re going to be at a much higher tax rate.

Joe: So Fish Sean Woo, if you do not want to control the money from the grave but you name the beneficiary as a trust just to make it easier on your beneficiaries, it’s not making it easier. Name people, name your spouse, name your kids, name your grandkids and make that on the beneficiary form. If you want to control the money from the grave, that you don’t trust your beneficiaries but you want to distribute the money out, then it gets more complex. Write us back or give us another question and say, “Hey, I don’t trust my beneficiaries. Give me some options of what I can do to control the money after I’m gone that’s sitting in a retirement account.”

Make things as easy and straightforward as possible for your beneficiaries. Give your loved ones a document that contains everything they need to know about your life, your accounts and your estate in the event of your passing. Download our blank Estate Plan Organizer from the podcast show notes at YourMoneyYourWealth.com, fill out everything, from your financial account details and insurance policies to your contacts and your final wishes, put it in a safe place, and give a copy to your family. Don’t forget to update it regularly. To get your free Estate Plan Organizer, just click the link in the description of today’s episode in your podcast app and you’ll see it right there under “Free Resources”.

Are These Good Reasons to Transfer Out of the TSP at Retirement? (Cass, Mississippi)

(voice recording) “Hey, Joe and Big Al, this is Cass from Mississippi. I drive a Chevy Equinox 2013. People say what they drink, too. Uh, Coke, is it. That’s it. And I have two Toy Fox Terriers named Boss and Smash and they are tiny and tough. So, if anybody breaks into my house, hey, be ready. So my question is about the TSP. There’s two reasons that I think I should transfer out of the TSP once I retire in 10 years, so that gives you guys plenty of time to answer this question. One is, when you withdraw funds, you don’t have a choice of withdrawing from just the bond fund. And that was kind of my plan to help stay rebalanced over the years. But you have to withdraw in equal increments from all the funds. And I’m wondering, is there some kind of workaround for this that I don’t know about? Or is it not terrible? Because I don’t understand how that’s good. But this is the great TSP, so I don’t want to give up on it. And the other thing is with a regular Roth in my Vanguard, I know I’m not going to have to take RMD from that. But the TSP Roth, you do have to take RMDs. So another thing I’m not crazy about. Do you think these two reasons are big enough reasons to transfer out of the TSP after I retire? I just wanted to get your thoughts on it and see what you think. I appreciate all your help and your good advice and the podcast is great. I love it. Stay cool.”

Joe: Yes. Gave me goosebumps.

Al: That’s a great accent, isn’t it? Wouldn’t it be fun to talk like this? TSP…

Joe: So Pro Thrift Savings Plan, which is a government plan. They have a few options.

Al: And people like those plans.

Joe: They’re very low cost. It’s totally diversified there. You can have a small cap index fund, an S&P, an international… So the TSP is a great plan. Very inexpensive. And it does the trick in regards to global diversification without the complexity of a thousand different funds.

Al: And it’s kind of on autopilot, in a way.

Joe: Sure, depending on what you want. And then they have target date funds.

Al: You have to pick your investments.

Joe: So let’s talk about the Roth 401(k) or the Roth TSP First. So if you have a Roth IRA, there is no required minimum distribution. If you have a Roth 401(k), and TSP basically falls into the 401(k) family, then Cass is right. She has to take a required minimum distribution from that account. She can roll the Roth into a Roth IRA and then that avoids the RMD altogether.

Al: So you can take the TSP part and roll that to Roth IRA, but you can leave the other part?

Joe: I don’t think so.

Al: It’s all or nothing?

Joe: I’m not 100% sure. As you can tell, we are super tight on this. But that’s easy to fix.

Al: You can find out if that’s possible, and that’s an easy answer on it.

Joe: Usually we would just roll everything. However, if that’s the case, you definitely want to get the Roth into a Roth IRA. That avoids the RMD. Especially if you don’t need the money or you want to control your distributions. In regards to her taking money from just the bond fund, I believe they changed the TSP rules recently over the last few years. Because she’s right, you could take one distribution from the TSP account per year, and when you did take the distribution, it needed to be pro-rata.

Al: Meaning an equal amount from each share or relative portion from each share, depending upon what you own.

Joe: Instead of picking and choosing. There’s a reason why this plan is dirt cheap.

Al: It’s simple and just kind of on autopilot for most people that don’t really understand all this.

Joe: There’s not a ton of people that are working in the administration behind this and saying, “Oh, you just want to take from the bond fund? No problem.” But everything is now getting automated online and so that should solve this problem, and I believe it did a few years ago when they did change some of the rules. Again, I did not do any type of research or preparation for this show today, so I do not have concrete answers. And we’re not giving advice anyway, we’re just chatting. Just talking about good ‘ole TSP.

Al: Yes, that’s what I’ve always heard too. The TSP, it’s inexpensive, they’re good fed funds, they’re globally diversified, they’re inexpensive. You can get good funds outside of a TSP that are very inexpensive nowadays with ETFs and index type funds, so you can do roughly the same. If you are interested more in self-directing and deciding Roth…

Joe: You can go to Vanguard, and Vanguard cost is a little bit more expensive than the TSP.

Al: Not much, though.

Joe: Not much. Depends on how much money that Cass has. Now, let’s say she has $1 million. It might cost her a few hundred dollars more.

Al: It’s not significant. If you want to self-direct, then pull the money out, roll it into an IRA and a Roth IRA, and then you can pick which funds you want to sell to get the money out for your RMD. If you don’t care, if you want to be on autopilot, just stick with the TSP.

Joe: I don’t know why you’re saying autopilot.

Al: Because then you don’t have to worry about which funds to sell. Because it’s just going to be an equal proportion. That’s what I mean.

Joe: But that’s a bad autopilot.

Al: But I’m just saying, a lot of people don’t care about this stuff.

Joe: But you don’t want to sell pro-rata. That’s why I don’t like target date funds.

Al: No, I understand your answer. I’m just saying, not for our listeners, but the 19 out of the other 20 people that don’t listen to our show, they don’t even care. Just, it’s easier. Simple.

Joe: Yeah, it’s a lot easier. But if a market is down 20%, you want to sell from the bonds, not the stocks. Or if the stocks are up 20% you want to sell from the stocks.

Al: But there is a quick workaround, which is if you have to sell pro-rata, if you want to buy more stocks than sell some of your bonds that are left to buy more stocks. You can rebalance that way.

Did I Pay Too Much Alternative Minimum Tax (AMT)? (Cindy, North San Diego County)

Joe: Cindy writes in. I guess we Ignored Cindy for quite some time, Alan.

Al: We did? OK, well, let’s get to it then.

Joe: It says “Hello, Joe, Al, and Andi. I really enjoy your TV and radio programs and appreciate you sharing your wealth of knowledge in such a fun and entertaining way. I have a tax question regarding AMT, alternative minimum tax. I tried contacting the IRS for an answer, but no help there. So for year 2013, I paid $25,000 in alternative minimum tax due to exercising incentive stock options after a job loss. In subsequent years, my income did not require AMT payments, and I received credits totaling $20,000 for the tax years 2014 through 2018. Due to being unemployed during 2014 and most of 2015, my income was very low, which made the AMT credits for 2014 and 2015 only $229 and $733, respectively. The credits were higher for 2016 through 2018. However, the total credits received from 2014 to 2018 were $5,095 less than the $25,000 amount of the AMT paid for 2013. Amounts for the line 25 and 26 on form in 801 for 2014 through 2018 are shown below. Is there any way I can still get the remaining $5,095 or is it too late?” So she’s looking for an additional tax credit.

Al: So let me translate. Alternative minimum tax is an alternative way to calculate income taxes. It came about in the 1950s or 1960s, when it was thought that certain wealthy individuals weren’t paying their fair share of taxes. They were loading up on deductions. And so the IRS and our politicians came up with an alternative way of calculating taxes. Similar but slightly different rules. And everybody, I don’t care who you are, everyone has to calculate their taxes both ways and whichever is higher, that’s the tax you pay. Now, many of us have never heard of it because our regular taxes are almost always higher than our alternative minimum taxes. But there are situations where it flips, and the alternative minimum tax, or AMT, is higher than the regular tax, and that would be in Cindy’s case. Because when you exercise incentive stock options, it’s not considered regular income on your W-2, but it is considered an alternative minimum taxable income. So in other words, you have higher income for AMT purposes than regular purposes.

Joe: They look at it as income for AMT purposes, but not for regular taxes.

Al: So as a consequence, and in this example, back in 2013, Cindy’s AMT taxable income was way higher than her regular taxable income. That’s why she owed the higher alternative minimum tax.

Joe: Because she exercised stock options. And some companies give incentives, some people give non-qualified. So the incentive she exercised, that created a lot larger taxable income, but it was a lot larger taxable income on the alt min schedule. Not necessarily her regular schedule.

Al: You got it. And so the way the tax forms work is you always pay the higher of the two. But the way the tax schedule works is you pay your regular tax and then you pay an extra tax for AMT. Even though you’re paying the AMT tax. It just shows up in two spots. So in her 2013, she paid an extra $25,000 of AMT tax. That’s what’s called a timing difference. In other words, when she actually then sells those shares, later, she’ll have a higher basis and she’ll have a lower gain for AMT purposes and this whole thing will reverse. And so she’ll get this money back. Or most of it, but not necessarily all of it. And here’s why, because back in 2013, and Cindy may not have known this, but part of her AMT tax was because of state taxes and property taxes that she paid, or miscellaneous itemized deductions that she paid that are not allowable for AMT purposes and are never allowable for AMT purposes. Therefore, it’s not a timing difference. You never get a refund of that part of the AMT tax.

Joe: So the $25,000 that she paid in alternative minimum tax, some of it was because of the incentive stock options. Some of it was for other deductions.

Al: That’s right. And so just round numbers, $25,000 AMT tax, $20,000 of that tax was because of the incentive stock options, $5,000 was because of, call it, state tax, miscellaneous, whatever. So therefore, when she filed tax returns later, she got credits of $20,000. So she’s wondering, wait a minute, I should get another $5,000 back. And unfortunately, Cindy, no. You got which you are entitled to, because $5,000 of that tax was related to things that do not turn around, are not timing differences. So that’s why. It’s a great question. Probably lost a lot of our listeners. But anyway, that’s the answer.

We’re Retiring Next Year. Should We Make Only Roth Contributions? (Ken, Fremont)

Joe: All right, we got Ken from Fermont.

Al: Fremont? or Vermont?

Joe: I don’t know. I was thinking Vermont, but it’s Fremont? Fermont?

Andi: Fremont, California.

Joe: “As I began searching for useful retirement planning podcasts last year, I stumbled upon Your Money, Your Wealth® and have not looked back. The stumbling could be related to the West Coast style IPAs I tend to favor”

Al: OK, Ken, you and I are the same.

Joe: “I appreciate the time you give to your listeners and the useful insights I gain from your show. I ride a 2013 BMC Gran Fondo. My wife and I are both 62 and I plan to retire in 2023. She will retire in June 2023, and I will retire in December 2023, which leaves us up to 24 more months to contribute to our employer plans. We contribute a total of $2,700 per month to our retirement accounts, of which only $650, 24% goes into my Roth 457 plan. We’re wondering if we should go all Roth contributions for the remaining time we are working and contribute to our 457 and 403(b) plans while 20% of our $1.2 million retirement savings is in Roth. As we begin retirement, income for my CalPERS pension is approximately $65,000 a year. Our Social Security is an estimated $60,000 a year and we will begin a few years later, aged 67 and 70. When we retire, we will begin withdrawing approximately $25,000 to $40,000 a year from our retirement accounts as a bridge to Medicare and Social Security to help fund our more active early years. Pension and Social Security income will be taxed. Would contributing a greater percentage to Roth accounts now be advantageous and give us more growth or income options in retirement? Even though we would be paying significantly more income in payroll taxes today. Thanks, Ken P. from Fremont, California” OK, so he’s got a couple of years. 20% of his $1.2 million, couple hundred thousand dollars is in Roth. He’s got a good pension of $65,000, plus his Social Security is going to cover most of his living expenses because he’s going to take a bridge to spend a little bit of money from the 401(k), $25,000 to $40,000, until Social Security comes into play as he’s pushing Social Security out until 67 for his wife and 70 for him. Should he just load up on Roth and maybe pay the tax and start building a little bit more tax free because only 20% of our overall portfolio is in Roth? At the end of the day, let’s say you go all Roth. What’s he going to have, like 23% now in Roth?

Al: Well, it helps, it does. But he still has a significant part in regular. So right now, the 24% tax bracket goes to taxable income of about $320,000. So let’s just say your taxable income between you and your wife is less than that. I would go Roth, because that’s a good rate. That same bracket is going to be probably taxed at 25% to 28%, even higher with alternate minimum tax in 2026. So I think that would be a good way to go.

Joe: I would agree with you.

Al: I knew you would say that because you always say go for maximum Roth. Especially in this situation, because a couple of years away from retirement, we’re in low brackets right now.

Joe: It’s $340,000 to the top of 24%. Let’s say, the tax rates change today where they’re expected to change in a few years. The top of the 25% tax bracket is at $180,000 of taxable income.

Al: Then you get to 28% and then you get potentially the alternative minimum tax, particularly if you live in California.

Joe: So, I would go Roth and I would also consider converting a little bit too.

Al: That’s not a bad call.

Joe: Because you’re still young. You got a lot of years to grow.

Al: Or at the very least to do more conversions. And when you retire, if your fixed income is lower, which probably will be at least for a while without Social Security, do big conversions between retirement and Social Security or between retirement and RMD.

Joe: Because he’s got this bridge here that he’s taking $25,000 to $40,000 out to live off of before he takes Social Security. Because he’s got the $64,000 pension, I would look and say, Hey, take the $25,000 or $40,000 out to live off of, but also probably convert to the top of maybe the 22% tax rate.

Al: Which is more like $180,000 taxable income. It’s up to $205,000 gross income, something like that.

Joe: So you pull out your $25,000 or $40,000 to live off of, and you could still convert maybe up to $80,000 to $100,000 and still stay in that 22% bracket.

Al: I like that, too.

Having your retirement plans well-defined in advance can give you more peace of mind. But the best plan for you and your family is highly individualized and entirely dependent on your current circumstances, your risk tolerance, and your goals for retirement. If you don’t have a financial plan, get one: visit YourMoneyYourWealth.com and click Get an Assessment to schedule a no cost, no obligation, one on one, personalized deep dive into your financial situation with an experienced professional on Joe and Big Al’s team at Pure Financial Advisors. Learn the strategies to help you make the most of your retirement, and to give you that peace of mind. Go to YourMoneyYourWealth.com and click Get an Assessment now.

The Best Way to Contribute to a Health Savings Account (HSA)? (Tyler, NJ)

Joe: We have Tyler from New Jersey. He writes in, “Hey guys. First of all, I love the podcast. Tons of great information. I like that you don’t take crap from people that send in crazy questions or leave nonsense reviews.”

Al: Yeah, we just let it roll off.

Andi: Joe makes fun of them!

Joe: No crap from no one. We do get some crazy questions.

Al: We do, and we try to answer them the best we can. Sometimes we make up what the missing things are, so we can answer them.

Joe: Then we just kind of make up our own question. “My question is in regard to my HSA health savings account. On January 1st each year, I directly contribute my portion (which will be $2,750 for 2022) into my health savings account from my regular checking account. Then throughout the year, my employer contributes their portion, $75 a month directly into my HSA bank account, maxing out the employee/employer contributions under a self only plan. Once the money hits HSA Bank, I immediately transfer it to my HSA investment account at TD Ameritrade and put it to work in low cost, diversified ETFs. I file the IRS form 8889 to reduce my adjusted gross income by the contribution amount.
I know that if I instead had my contributions come out via payroll, I wouldn’t have to pay the FICA tax on those contributions. In my head, the FICA tax, which is 7.65% percent of $2,750, is about $206 of tax savings. On the other hand, if instead I invest at $2,750 right away on January 1st, I feel like my money can earn more than $206 of tax savings over the span of the entire year. Am I missing some in this equation where it would make more sense due to the contributions via payroll? Thanks for the feedback.” Alright, Tyler from Jersey. What do you think, Al?

Al: No, Tyler, you’re not missing anything. So first of all, I agree. If you have your contributions through payroll, you don’t have to pay the FICA tax on those contributions. So there is an advantage there. But the sooner you get the money invested, the sooner you have growth. If you have a 10% growth rate, that’s $270 bucks. If you have a 7.65% rate, it’s the same number. My main answer is I don’t really care.

Joe: Because you’re Big Al. You got a big wallet, because it’s pennies, $200.

Al: No, because the difference between the growth in $206 is probably $25 bucks. That’s half a dinner. I don’t really care that much, but the real answer is do what you want. It’s not that big a difference.

Joe: Alright, HSA. We got a couple of minutes to explain that. Health savings account, for those of you that don’t know what Tyler’s doing. He has a high deductible insurance plan. And so what that means is that the premiums of the insurance is a lot lower. And so you’re making up for the savings of premiums and you are allowed to put a certain amount of money into a pre-tax account that grows tax deferred and that you can pull the money out 100% tax free if you use it for qualified medical expenses.

Al: And you don’t have to use it that year, it can grow for decades.

Joe: So what he’s doing is like, you know what? I’m healthy. I don’t think I’ll need this. So he’s taking the money and he’s moving it from a checking account directly into an investment account. And so that investment account is growing, tax deferred. And if you ever need some of that money, it’s like another Roth option if it’s used for medical expenses. Or, over time, he can just convert that into another retirement account.

Al: It’s even better than a Roth because you get the tax deduction and it’s tax free for medical.

Joe: It’s a triple threat. So, you get the tax deduction, tax deferred and tax free coming out if used for medical. But if he doesn’t use it for medical, you can just roll it into another IRA down the road. So check it out. If you have an HSA through your employer, it might be a decent option.

Should I Sell Restricted Stock Units (RSU) for Long Term Capital Gains or Short Term Capital Gains? (Mike, DC)

Mike, from D.C., writes in, he goes, “Hey Joe and Al. Love the podcast. Keep up the great work.” We will do so, Mikey from DC.

Al: Well, we’ll try.

Joe: I have RSUs vesting,” that’s restricted share units.

Al: Stock units.

Joe: Thank you.

Al: I guess that’s the same thing. It just sounded more better.

Joe: More better, got it. So he’s got some restricted stock units vesting in May, “and I have been told by everyone I speak to and read is to sell right away once they vest. I was planning to do so. But during my company’s blackout period, where I’m not allowed to buy or sell, the next open trading window would be about a month later. If I sold them, then it would be treated as short term capital gains on any gains I accrue. My question is, should I sell regardless of the short term capital gain on June 18th or hold the RSUs for a year to get long term capital gain treatment, but potentially have more risk if stocks go up or down? Also, I participate in my company’s ESPP–” gets a 15% discount “–and wanted to know your thoughts on if I should sell once I get them, or keep it for two years to avoid high taxes, but similar to RSUs, potential risk of stock going down. Any help would be great. Appreciate it.” All right, so Mike is an executive. He’s got some executive comp plans and he’s curious on what the heck to do. So, Alan, why don’t you explain RSUs?

Al: Restricted stock unit. So basically you get granted a right to a stock unit at some point in time and then there’s some kind of vesting period. Two years, three years, five years, whatever it may be. And the thing is, as soon as it vests, it’s taxable as compensation.

Joe: Yeah, it comes right on your W-2.

Al: Right on your W-2. It could have been granted to you for a dollar share, but if it’s $10 a share when it vests, you have to pay tax on $10 a share right on your W-2. It gets put right on your W-2. And that’s why, if you’re new to these kinds of things, sometimes you’ll have pretty high W-2s. Because when these things vest, they’re fully taxable at whatever they’re at at the time. This is why Mike, most people sell.

Joe: Because they’ve already paid the tax.

Al: Because they can’t afford the tax. It’s like income. You’ve got $100,000, $50,000, $200,000 of income that you didn’t have any withholding on because it’s not dollars, it’s stock. So that’s why you sell it so that you can pay the tax because it’s all ordinary income. So it’s whatever federal and state tax bracket you’re in, that’s what you’re going to have to pay.

Joe: So let’s say it’s worth $10. You’re paying $10 of ordinary income tax, but you owe $5 in tax and people don’t have the $5 in tax. So they’re like, OK, well, you know what? Just give me the cash because it’s already showing up on my W-2.

Al: That’s right. And the $10, multiply that by a 1,000 shares or whatever the shares, it can be a pretty big number. So that’s why people usually sell. Now in your case, you’ve got a blackout period where you can’t do that. So I understand that. If you then sell right after that again, it depends whether you need the money to pay for the tax. Let’s just say if you need the money, then go ahead and sell it because you need the money. So there might be a little bit of additional ordinary income if it went up further from that point.

Joe: So what he’s worried about, let’s say, it’s $100 a share and he has 100,000 shares. So it’s a big number.

Al: That’s a big wallet.

Joe: Yeah, that’s giant. I wish I had Mike’s wallet. So he’s going to have to pay tax on that $100 a share, depending on how many shares that he has, right there on his W-2, that’s going to show up. But he can’t sell the shares until a blackout period. So if the stock goes from $100 a share to $150 a share from the blackout period, he’s going to pay another tax on that $50 increase from the vesting date. Not the whole thing again.

Al: He’s already paid tax on the first $100 in your W-2. Let’s just say you can afford to pay the tax, and if you are bullish on the stock, you think the stock is going to go up or at least stay the same. If it stays the same, there’s actually not much consequence because there’s no additional capital gain. But if you think the stock is going to go up and you’re pretty confident about that, there’s risk. Because it might not. But if you can wait a year, then you’ll get long term capital gain on that extra piece, the extra $50 in your example. But there’s a lot of risk in that, and this is why most people sell when they vest because they can’t afford the tax and they’re not willing to take the risk.

Joe: And he’s in a similar boat to other people that have RSUs is that he’s also participating in employee stock purchase plans. An ESPP. And so basically what that is, is that whatever organization or a company that he works for, it’s another incentive plan for people to act like owners of the company. Hey, we’re giving you the opportunity to buy-in company stock at a discount. So he has the ability to purchase company stock at a totally different price than the street. So because he’s an employee, he can purchase it at a 15% discount versus Al and I or anyone else has to purchase it at full price.

Al: And furthermore, some of those plans allow you to purchase it at the lowest price over the quarter, not even necessarily the closing price.

Joe: Yeah, you get the 15% discount based on a moving average.

Al: It just depends upon the plan, but that could be the case, and that’s that’s a good deal.

Joe: Because you got a 50% locked in return.

Al: As long as you’re bullish on the company. If you’re not bullish on the company, if you think the company might be in trouble, then don’t do it because this is an investment. But the idea here is a little bit different than RSU, because once you buy it, you have the discount. There’s no taxation. And until you sell it, if you wait a year, it’s going to be long term capital gains. So that would be advantageous. Again, you’d only do it if you’re bullish on the company.

Joe: Some people take advantage of these plans and then they sell out as soon as they can, even at short term capital gains. They pay the ordinary income tax because the 15% discount might have been greater than the tax that they had to pay. So there’s an arbitrage there.

Al: That or the fact that they think, you know what? This has really shot up. I don’t think it’s going to stay, Then sell it. Don’t worry about the tax. Cash in what you can.

Joe: Because if you think about it, Mike, your income, your wages are coming from that organization. You got RSUs that are coming. So if everything is tied into your company… a lot of concentration there. But that’s how you get super rich.

Al: If you got the right company.

Joe: Or you get super poor. Have you ever seen The Smartest Guys in the Room, like with Enron? Have you ever seen that movie?

Al: No.

Joe: It’s kind of like a documentary. And all these employees are in there and they’re like, “Keep buying stock!” And then, the next scene is like, “Oh my God!” I’m not saying this company is Enron. But you know. Alright, we’ll see you guys next week. The show is called Your Money, Your Wealth®.

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