For founders and highly-compensated early employees, acquiring a significant amount of startup stock at a low price presents a valuable opportunity. One strategy to maximize the potential of these stocks is to transfer them into an Individual Retirement Account (IRA), creating a potential source of substantial retirement wealth. It is prudent to diversify concentrated positions of wealth by selling the startup’s stock at the right time. Using an IRA to sell the stock avoids the 50% taxation that normally occurs, and the compounded benefits of deferring this tax across a lifetime can be enormous.
While the process of transferring stocks to an IRA may seem simple, the expert guidance of finance professionals can help maximize wealth while minimizing the tax burden. Understanding how the IRA stock transfer strategy works can help streamline the process and is critical to ensuring stable financial health well into retirement.
Why Transfer Stocks to Your IRA
While IRA contributions are subject to annual limits, transferring stocks into an IRA offers a unique advantage for stockholders. By contributing stocks with a low fair market value (FMV) to the IRA, you can leverage the low current value without exceeding the contribution limit ($6500 as of 2023). This is especially applicable to founders and early employees. The IRA enables the deferral of tax from future stock gains regardless of hold times, allowing all your profits to grow within the IRA without the headwind created by taxes. Although eventually taxed at the time of withdrawal, that typically occurs during retirement when tax rates are lower. The ability to buy and sell stocks within an IRA without hold time requirements, such as the 1-year needed for long term capital gains, can greatly reduce portfolio risk during volatile times. Over time, this strategy of using an IRA can yield significant value with a relatively small upfront cost.
The Roth IRA Difference
A Roth IRA is even better than a regular IRA because even the final withdrawal is tax free. The catch is participation is limited to individuals with lower incomes (maximum income of $138,000 for single filers and $228,000 for married couples filing jointly as of 2023) and the annual contribution limits are capped. The income limits will exclude many technology professionals with the notable exception of founders who might not be getting fully paid during the early years of a startup. That presents a golden opportunity for founders to contribute some portion of their stock to a Roth IRA while the value is low enough to fit within the annual contribution limits ($6500 as of 2023). The tax-free earnings from these startup shares can be enormous over time. Since the tax benefits of the Roth are deferred until retirement, it is recommended that founders keep some shares outside of their Roth accounts to generate taxable earnings prior to retirement.
Those not meeting the income requirements can still participate in Roth IRAs via a conversion of their traditional IRAs. This is where you move a portion of your IRA value into a Roth IRA and pay ordinary income taxes at your current tax rate on the value of the portion moved. Again, founders and early employees who can take advantage of the relatively low FMV of their stock by contributing those shares to an IRA and then immediately converting them to a Roth IRA by paying income tax on that low value. Even if the stock was contributed earlier while the value was below the $6500 annual limit and the value is now higher, it still isn’t too late. If the value hasn’t risen too high then you can still convert as long as you can afford the cost of the higher taxes based on the current value of the stock. Once converted, you will also enjoy the potentially enormous tax savings down the road.
Maximize Stock Success With ESO Fund
Doing this starts by creating an IRA account at a custodian that allows the holding of private company stock. At the time of this writing, ESO clients have had success doing this with Charles Schwab, Pacific Premier Trust, and Fidelity. There may be other organizations that also allow the holding of private company stock within an IRA account. When you research this, the feature is more broadly referred to as holding Alternative Assets. The various custodians will have different requirements before permitting investments in alternative assets. These include but are not limited to client investment experience and the asset itself – whether the company is legitimate, viable, and compliant with valuation reporting requirements. Of course, the fee structure between custodians can vary considerably depending on the value of the asset and the overall client portfolio.
Indeed, there are a number of rules associated with IRA investing that users need to look out for. Founders who own a large percentage of their company, in particular, need to pay attention to the gray areas associated with both traditional and Roth IRAs, as do employees within their startups. Executing all of this without error while maintaining one’s career and personal life can be challenging. There are many restrictions and potential pitfalls to look out for that only an experienced financial professional can identify. The Employee Stock Option Fund (www.ESOFund.com) is in the business of private company stock and maintains a knowledge base as well as an ecosystem of professionals to help you be successful. Feel free to contact the ESO Fund for general guidance or referrals to wealth management professionals and financial advisors.
For startup shares that are ineligible for IRAs or intended for personal liquidity before retirement, the ESO Fund can also provide financial assistance to reduce the costs, risks, and taxes associated with purchasing startup stock via the exercise of employee stock options. Navigating the stock option exercise process doesn’t need to be difficult. With ESO Fund, startup founders and employees are partners, not customers. You get all of the best guidance and advice alongside the funds you need to exercise your stock options. With ESO Fund, you’ll have a trusted partner who understands the regulations and can provide the liquidity needed to successfully exercise your stock options. Build wealth for tomorrow by getting the funds you need today to make your best financial move.
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