There is a particular kind of financial risk that long-tenured employees tend to accumulate without fully realizing it. They participate faithfully in the ESPP. They hold the company stock fund in their 401(k). They receive equity grants or matching contributions in company shares. And over 15 or 20 years, they end up with a very large percentage of their net worth tied to the performance of a single company.
The same company they work for.
This is concentrated stock risk, and it is one of the most common and most underappreciated vulnerabilities in the retirement plans of corporate employees. The good news is that there are strategies for reducing this concentration in a tax-efficient way. The bad news is that most people wait too long to act.
Why Concentration Is a Retirement Risk
Diversification is one of the foundational principles of investment management, and for good reason. A portfolio concentrated in a single stock is exposed to company-specific risk that a diversified portfolio is not. A regulatory change, an earnings miss, a product failure, or a broader industry disruption can cause a single stock to decline 30%, 50%, or more, while a diversified portfolio experiences a fraction of that loss.[^1]
The risk is compounded when the concentrated stock is also your employer. If the company has a bad year, you may face a declining stock price at the same time as layoffs, reduced bonuses, or other financial pressures. The correlation between your human capital and your investment portfolio is exactly the wrong kind.
For someone approaching retirement with a large portion of their net worth in company stock, this is not a theoretical risk. It is a real vulnerability that needs to be addressed before retirement, not after.
The Tax Challenge
The reason most people delay diversifying is the tax bill. If you have held company stock for years and it has appreciated significantly, selling creates a taxable event. The gain is subject to capital gains tax, and for large positions, that can be a meaningful amount.
But the tax bill from diversifying is almost always smaller than the risk of not diversifying. A 15% or 20% capital gains tax on a gain is a known, manageable cost. A 40% or 50% decline in a concentrated position is an unpredictable, potentially catastrophic one.
The goal is not to avoid the tax entirely. It is to manage the timing and structure of the diversification to minimize the tax impact while reducing the concentration risk.
Strategies for Tax-Efficient Diversification
Several approaches can reduce the tax cost of diversifying a concentrated stock position.
Spread sales over multiple years. Rather than selling the entire position in one year, spread the sales across two or three years to manage the capital gains in each year and potentially stay within a lower tax bracket. This is particularly effective in the years between retirement and Social Security, when taxable income may be lower than during working years.
Use the NUA strategy for 401(k) stock. If the company stock is held inside a 401(k), the Net Unrealized Appreciation strategy may allow you to distribute the shares in-kind and pay capital gains rates on the appreciation rather than ordinary income rates. This is covered in detail in a separate article, but it is one of the most powerful tools available for 401(k) company stock.[^2]
Harvest losses elsewhere to offset gains. If other positions in your portfolio have declined in value, selling them to realize losses can offset the capital gains from selling company stock. This tax-loss harvesting approach can meaningfully reduce the net tax impact of diversification.
Donate appreciated shares to charity. If you have charitable giving goals, donating appreciated company stock directly to a charity or donor-advised fund allows you to avoid the capital gains tax entirely while receiving a charitable deduction for the full fair market value. This is one of the most tax-efficient ways to both reduce concentration and achieve charitable objectives.[^3]
Use the ESOP diversification option if available. Some employer plans allow participants who are 55 or older with at least 10 years of participation to diversify a portion of their ESOP account into other investments. At age 60, the limit is typically 50% of the cumulative vested shares. This is a plan-specific provision and not all plans offer it, but it is worth checking if you have a significant ESOP balance.[^4]
The Timing Question
The best time to address concentrated stock risk is before retirement, not after. In retirement, you lose the ability to spread sales across high-income and low-income years in the same way. You also lose the ability to use employer plan provisions like the ESOP diversification option once you separate from service.
A pre-retirement review of your company stock holdings, including the cost basis, holding periods, and tax profile of each position, should be part of any comprehensive retirement planning process.
The Bottom Line
Concentrated company stock is a real risk, and it is one that long-tenured corporate employees are disproportionately exposed to. The tax bill from diversifying is real, but it is manageable with the right approach. The risk of not diversifying is also real, and it is not manageable once a significant decline has already occurred. The time to address this is before retirement, while you still have the most options available.
References
[^1]: Kiplinger. "Concentrated Company Stock: Don't Wait Forever to Diversify." Kiplinger.com. https://www.kiplinger.com/retirement/retirement-planning/concentrated-company-stock-in-your-esop-how-to-diversify
[^2]: Internal Revenue Service. "Topic No. 412: Lump-Sum Distributions." IRS.gov. https://www.irs.gov/taxtopics/tc412
[^3]: Internal Revenue Service. "Publication 526: Charitable Contributions." IRS.gov. https://www.irs.gov/publications/p526
[^4]: Peak Wealth Planning. "The Diversification Option: Understand Your ESOP Benefit." peakwealthplanning.com. https://www.peakwealthplanning.com/post/the-diversification-option-understand-your-esop-benefit
Jason Rindskopf is the founder of Two Waters Wealth Management and creator of the SMART Retirement Blueprint®. He works with high-achieving professionals and couples in the Charlotte, NC area who are within 10 years of retirement or recently retired. If you'd like to talk through your your concentrated stock position and diversification strategy, book a complimentary consultation here.