Concentrated stock positions can be a double-edged sword for investors. On the one hand, they offer the potential for substantial wealth accumulation, but on the other, they come with a high level of risk and can lead to financial vulnerability if the stock takes a downturn. In some cases, these individuals may not need the income for retirement and wish to pass on these assets to the next generation. However, this could also subject the beneficiaries to the same level of volatility and instability when the stock is ultimately inherited. Fortunately, there's a strategic approach that savvy investors and financial advisors can use to mitigate this risk: diversifying concentrated stock positions with life insurance.
In this article, we'll explore the benefits of using life insurance to achieve financial diversification while maintaining control and flexibility.
The challenge of concentrated stock positions
First, it’s essential to understand the challenges that concentrated stock positions pose:
- Lack of diversification: Concentrated positions often mean that a significant portion of an individual's wealth is tied to a single stock or company. This lack of diversification exposes investors to higher risks. For example, imagine you work for a tech company, and most of your wealth is tied to company stock options. Your financial well-being becomes highly vulnerable if the tech industry experiences a downturn.
- Market volatility: Stock prices can be highly volatile, and fortunes can change rapidly. Consider a scenario where you've invested heavily in a single pharmaceutical company. Unexpected clinical trial results or regulatory changes could lead to a sharp decline in the stock's value, potentially jeopardizing your financial stability.
- Tax consequences: Selling concentrated stock positions may incur significant capital gains taxes, reducing the overall proceeds received from the sale. This tax burden can be substantial, especially for long-held assets.
These examples illustrate the real-world challenges individuals face when holding concentrated stock positions, emphasizing the need for strategic solutions like diversification through life insurance.
Diversifying with life insurance
Life insurance can be a powerful tool to address these challenges and achieve diversification. Here's how:
- Tax-efficient liquidity: When structured correctly, life insurance policies can provide tax-free withdrawals and loans, granting access to the policy's cash value without incurring capital gains taxes, offering an efficient way to create liquidity.
- Preservation of wealth for heirs: Life insurance allows an individual to protect their family's financial future by designating beneficiaries who will receive a death benefit upon their passing. This ensures that heirs receive a tax-free payout, regardless of what happens to the stock market.
- Control and flexibility: Unlike selling stocks, where control of the assets is lost, life insurance policies provide control and flexibility. The individual can access the policy's cash value when needed, borrow against it, or adjust the coverage.
- Risk management: Life insurance serves as a risk management tool. If stock portfolios take a hit, the death benefit from the life insurance policy can help offset losses, providing stability for the future and the next generation.
Steps to diversify concentrated stock positions with life insurance
By implementing these steps with a financial or insurance advisor, an individual can proactively address the risks associated with concentrated holdings while preserving and growing your wealth tax-efficiently.
- Assess the situation: Evaluate the financial position, objectives, and risk tolerance and consider how much wealth is tied to the concentrated stock position.
- Consult a financial advisor: Seek advice from a qualified financial advisor or wealth manager specializing in diversification strategies. They can help determine the appropriate amount of life insurance coverage and the type of policy that suits the individual’s needs.
- Choose the right life insurance policy: There are various life insurance policies, such as term and permanent life insurance, and each has unique features and benefits. However, it may be best to pick a policy whose cash value is not tied to the stock market when trying to diversify concentrated stock.
- Monitor and adjust: As an individual’s financial situation evolves, periodically review and modify the policy to ensure it continues to meet changing needs.
Diversifying concentrated stock positions with life insurance is a strategic approach that can provide financial security, tax efficiency, and peace of mind. By leveraging life insurance benefits, you can manage risk, maintain control, and create a path to financial freedom for yourself and your heirs.
John and Beth, aged 65 and in good health, have a net worth of $10,000,000. They also have about $5,000,000 in a concentrated stock position. They have more than enough other assets to provide for their retirement comfortably. They wish to pass off the stock to the next generation but are worried about potential volatility during their lifetime and after the assets are passed down. They were looking for a strategy to provide more stability and approached their advisor for ideas.
It was suggested that they allocate a portion of their stock portfolio, in this case $1,000,000, towards purchasing a life insurance policy. After paying the capital gains tax, they are left with a net amount of $850,000. They then buy a policy and use the net amount as a single pay with no further premium going forward. This would yield a death benefit of $2,697,685* and is fully guaranteed for their lifetime. The policy includes a secondary guarantee feature to remain in force regardless of adverse market performance. At their passing, the beneficiaries would receive the life insurance proceeds tax-free, along with the remaining assets in John and Beth’s estate.
A tech-enabled life insurance brokerage like Modern Life can play a pivotal role in helping advisors ensure their clients diversify their concentrated stock positions effectively. Here's how:
- Seamless onboarding: With a tech-enabled brokerage, onboarding a new client is easy with digital intake forms. Advisors can share medical and other forms with the click of a button to have clients fill them out.
- Document management: With a tech-enabled brokerage, there’s no need to dig through old emails for documents. Advisors can retrieve, review, and upload files on Modern Life's dashboard, where our team can check them if needed.
- Expert guidance: Brokerages are well-versed in the intricacies of various insurance products and can provide expert advice tailored to an individual's specific financial situation. They assess the extent of concentration in stock holdings and work closely with advisors to understand their client’s goals and risk tolerance.
- Customized solutions: A brokerage can recommend and customize life insurance policies that align with the client's objectives. This includes selecting the appropriate type of policy and coverage amount, and structuring it to maximize tax benefits and liquidity.
- Access to insurance markets: Brokers can access a wide range of insurance carriers and products. This access enables them to shop the market for policies that offer competitive features and costs, ensuring clients get the best value for their investment.
- Policy management: Brokers assist in ongoing life insurance policy management. They monitor its performance, help clients make adjustments as needed, and ensure that the policy continues to align with the client's evolving financial goals.
- AI tools: Modern Life has a chat capability powered by generative AI, trained on thousands of pages of life insurance data. Consider it a resource to help you get more done, including generating marketing materials and explaining complex topics for clients.
* Based on Prudential’s survivorship index UL, assuming a male and female, age 65, both in preferred health.