Protecting share options profits in this tired Bull Market

Share option schemes: Is it time to get off the bus?

We are getting towards the end of a bull run!’ is a line doing the media rounds at the moment. Yet employees with stashes of unexercised share options hang on in hope. Some simply feel uneasy, even disloyal, to dispose of their employer’s shares.

Others are reluctant to exercise share options as the gains are fully taxable, at up to the 40% maximum marginal rate. So to wipe out a substantial proportion of a personal balance sheet seems incomprehensible.

Lets examine best and worst case scenarios.

Best case scenario

Markets will continue to flourish. Tax rates will hold at their current levels. The Rand will hold firm. Share option values will increase faster than a balanced portfolio of investments.

We would all like to believe the above is sustainable. But a quick reality check will at least identify substantial risks inherent to the best case scenario.

Many holders of unexercised share options are simply ignoring the fundamental premis of investment strategy – security is found in diversity.

Imagine a dealing room of a financial institution with just 10 percent of the investment portfolio in one counter. The risk committee would freak out. Yet members of that very risk committee may easily have 50 percent of their personal wealth tied up in unexcersised share options. Its bonkers!

The worst case scenario

Markets could fall or stagnate. Come October 2014 the medium term budget framework speech may well reflect that tax collections are below target as a result of slowing growth rates, lack of consumer confidence and wide-scale strike action. We could even see an increase in the maximum marginal tax rate above 40% in the national budget speech in February 2015. The implications of increasing the VAT and corporate tax rate are far too severe to consider. Other taxes are too small to patch up a hole in the national deficit.

An increasing national deficit could well place the Rand under pressure. So even if the JSE does continue to perform, this must be tempered by the effects of a declining Rand.

But there is more to the debate.

If share options are exercised in the tax year of assessment ending 28 February 2015, 15% of the gain can be contributed to a retirement annuity fund tax-deductible. There is currently no limit to this deduction. This reduces the effective maximum marginal tax rate from 40% to 34%. From the 2015/16 year of assessment, total tax-deductible retirement fund contributions will be capped at R350 000 per annum. So February 2015 is the last big chance to flip a portion of one’s share options into a RAF.

The cash after-tax proceeds of the share options after the RAF contribution can then be placed in a diversified portfolio that hopefully anticipates JSE and exchange-rate volatility.

Unexercised share options are accumulating both income-tax and estate-duty exposure. The modern RAF controls both. And diversified share portfolio growth should only be subject to CGT at a maximum rate of 13,3 percent.

The cost structures, if you shop around, are a fraction of what they used to be. And the living annuity principle can leave the actuary and life expectancy out of the picture.

Conclusion

Perhaps wealth creation is not so much about how much you made in good times, but rather, how much you didn’t lose in bad times. Thus, diversifying investment portfolios against obvious risk is essential. Holding onto a stash of share options in one company simply does not achieve that.

If we are indeed looking at the end of a bull run, waiting until February 2015 to take advantage of the RAF break may be to late. The time to limit risk is now.

Donations in lieu of this free advice can be made to any SPCA office. Better still, adopt a mutt and name it RAF.

This article also appears on www.biznews.com


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