Tax free way to swap RSUs into portfolios.
If you work in tech then you've 100% thought about how to avoid taxes on your RSUs more than once.
Exchange funds let you swap your RSUs into a portfolio without having to sell them, which avoids 100% of capital gains tax.
Does it sound too good to be true? It almost is.
Before we dig into exchange funds, also known as "swap funds", you need to understand why they exist. Swap funds first became popular in the late 90s and they were originally conceived as a way to help people who hold concentrated position of stock diversify to reduce risk.
A concentrated position is when you hold over 20% of your assets in a single stock. This introduces a lot of risk - and financial advisors commonly recommend against it.
Concentrated positions are something most tech employees encounter early in their career - but 20 years ago, when swap funds were first being introduced, it was mostly a problem executives had (since no one else got paid in stock).
How swap funds reduce portfolio concentration
An swap fund allows you to replace a concentrated RSU position with a diversified basket of stocks of the same value, reducing portfolio risk and putting off tax consequences until later.
You don't pay capitals gains to swap into an exchange fund - but you will pay them later when you sell your position in the fund.
Setting up these funds is not easy:
Exchange funds are private funds - this means they pool the stock of many individuals and those individuals essentially swap between each other. The government also has some requirements on what can go into the funds and how long they need to be held.
These funds are usually set up for executives or other high net worth individuals by a bank or large financial institution. Minimums usually start at $500,000 but some funds will have higher requirements ( we've seen up to $5M)
Here is the process:
To get the full benefits of the fund, investors need to hold their positions for at leats 7 years - this means you can't sell without penalty and you have to trust your swapped portfolio will do well. If you need cash to maintain your lifestyle or you're near retirement- these funds are a bad option for you.
These funds can also come with hefty fees, all of which are usually due up front. This may pay off in the long run, considering the tax savings, but it really depends on the quality of the fund.
Lastly, these are passive funds. There is no portoflio manager or strategy behind them. What you swap for is what you get.
Long story short: these funds can be a bgreat option if you're a
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