I recently retired at age 65 with a pension. About one-third of my savings are shares in my former employer (a large public company), which I purchased through stock options over the years. I'm concerned that having so much in a single stock is far too risky in retirement. However, if I sell the shares now and buy something less volatile - like bond ETFs or GICs - then I'll face a huge tax bill for the capital gains. Any thoughts on how I can diversify without suffering too badly in taxes?
A: Many companies offer stock purchase plans for their employees, and these can be an excellent way to build wealth over time with payroll deductions you may not even notice. However, as you've found, Nick, the downside is they can result in a large part of your net worth being tied up in a single company's stock. This concentration risk is even more acute when that company is your employer: if the business hits a bad stretch, you may find yourself out of a job and holding a crippled portfolio.
That's why it's usually best for people in this situation to gradually divest of their employer's stock as soon as they can. Many stock plans have a vesting period (for example, you might need to hold the shares for at least two years), but when this is over, you can reduce your risk by selling and investing the proceeds in a diversified portfolio. Doing this regularly can also allow you to spread the tax bill over many years.
In your case, Nick, it's too late for that, so let's consider how you might handle your predicament. I'll preface my comments by saying this is not a plan you can sketch on the back of a napkin: you should work with a financial planner and your accountant to find the best solution. Here are some things to consider:
How risky is the stock?
You mention your employer was a large public company, which may reduce the risk somewhat. It's one thing to hold a big position in a solid blue-chip stock, and quite another to concentrate your wealth in, say, a start-up with a billion-dollar valuation and no earnings.
In the former case, it might make sense to gradually divest of the holding over several years so you can spread out the tax liability. In the latter, I'd suggest shortening that timeline, even if it means a bigger tax hit. It's more important to reduce the risk of a devastating loss than to keep your taxes to a minimum.
Take advantage of the end of the year
If you're planning to gradually liquidate a holding with large capital gains, December can be a good time to get started.
Say you have unrealized gains of $150,000 on your former employer's stock. You could sell one-third of the shares now, realizing a $50,000 gain that you would report on your 2018 tax return. Then in January, you could sell another third, and this would not need to be reported until you file your 2019 return in the spring of 2020. Finally, you could sell the remainder of the stock in January 2020. This would allow you to liquidate the entire position in only 14 months, while spreading the capital gains over three tax years.
Consider deferring government benefits
Nick, at age 65 you are eligible to collect both Canada Pension Plan and Old Age Security benefits. But if you're anxious to sell some of your company stock, you might consider deferring your CPP and OAS for a couple of years and instead supplementing your income by selling your stocks gradually during that time.
This strategy can have a couple of benefits. First, the capital gains may be taxed at a lower rate than they would have been if your government benefits pushed you into a higher tax bracket. Second, when the stocks have all been sold, you'll receive higher CPP and OAS benefits because you deferred them.
Harvest any future losses
Even after you've sold your stocks and paid the capital gains taxes, there's still an opportunity for some relief. If your new portfolio declines in value, you can "harvest" any capital losses. (You should then immediately buy back a similar ETF to maintain your market exposure.) You can then apply to have these losses carried back to offset some or all of the gains you realized on your stocks. Losses can be carried back for up to three tax years, and you'll need to file a T1A Request for Loss Carryback form with CRA. A professional tax preparer can definitely help here.