(4 minutes to read)
When new clients start with us, it’s often the beginning of a multiyear journey along the path to a bigger, better financial future. But first, before we can begin taking strides toward their vision and goals, we often need to perform financial triage to clean up messes clients might not be aware of. Here are a few short stories about issues we’ve faced that highlight why professional oversight can be so crucial.
Common Oversights
This week we are rebuilding a prior year’s tax return for a new client who is convinced he paid tax twice on restricted stock unit (RSU) share sales. He may be right. That’s a subtle issue and it can be hard to spot. It’s also more common than you might think.
Two families who recently became clients owed five- and six-figure back taxes plus penalties and interest because incentive stock option (ISO) exercises were not properly recorded on prior year tax returns. We had to let them know the bad news. That’s a tough way to start a new relationship.
Most people start with several old 401(k)s from previous employers that they haven’t looked at in quite a while. They may not even know where the accounts are anymore, which of course means they can’t possibly be on top of the investments inside. Getting those old 401(k) plans aggregated somewhere, either in a rollover IRA or their current employer’s 401(k) plan, is a first step to getting those assets growing again.
One client’s IRS notice about back taxes turned out to be about a loan taken out of a 401(k) account that wasn’t repaid after terminating employment. If the loan isn’t repaid by the deadline, the total amount of the loan is considered income and is taxed at ordinary income rates. The mystery was solved, but that’s a tough way to learn about 401(k) loan repayment deadlines.
Unexpected Discoveries
This situation was with an existing client working for a new company. The client’s new employer went public relatively soon after the client joined, and the client exercised non-qualified stock options (NSOs) with nearly $2 million in value.
The company, though, through a mix-up with their payroll provider, didn’t report the exercise as compensation income on year-end tax reporting documents as required. We spotted the issue during a regular comparison of tax projection versus actual tax return, and the client received a notice from the IRS about back taxes, penalties, and interest.
Working with the client’s tax preparer, we were able to get the penalties and interest waived. This is a reminder that new situations pop up in previously stable financial lives too, often from unexpected sources, and it’s important to have error detection systems in place.
A client listed her income in the onboarding questionnaire, but when we reviewed her two paystubs, the income didn’t match. It turned out the company forgot to bump up her salary after her promotion about six months earlier. Neither she nor the company had noticed. The extra income more than covered her first-year fees.
Our review of a new client’s tax return showed dividends from an investment account they hadn’t mentioned. With some detective work, we found that it was a long-forgotten brokerage account with substantial assets. Fortunately, the brokerage firm was still sending Form 1099 tax-reporting statements to the client, so we were alerted to the missing money.
Eye-Opening Moments
“Where did you get those numbers?” This is one of my favorite questions from new clients after we tally up their ongoing expenses, especially because our answer is: “From you.” This is the moment when many new clients realize how much they’ve been spending, and it truly shocks them. A number of people believe they don’t spend very much, but their credit card statements say otherwise. Gaining this awareness is a crucial step in building a secure financial future—leading clients into a time of making more deliberate spending decisions about what’s most important.
A prospective client in her late thirties said she had left her company about four months ago. She went on to list the amount of incentive stock options (ISOs) and non-qualified stock options (NSOs) she had that were vested. It was in the low seven figures of market value. A loud siren was going off in my head as we talked. I asked her to look at her grant letter to find out how many days after terminating employment she had to exercise those options. Ninety days is common. She couldn’t find it and said she would go look for it and call me back. She never did. I’m assuming it was the worst-case scenario, and she discovered she had lost all that money because she didn’t exercise her options within the allotted window—a heartbreaking disaster that could easily have been avoided.
Ongoing Challenges
The challenges I beat myself up over the most are the concentrated stock cases. New clients and existing clients can find themselves holding a substantial portion of their net worth in their company’s stock after an acquisition, initial public offering (IPO), or run-up in the stock price. Despite my best efforts to encourage them to diversify, sometimes I’m not successful.
If the stock has been trending up recently, they may be feeling, “I can’t sell now; the stock is going up.” Or if the stock dipped recently, they may be feeling, “I can’t sell now; the stock will bounce back.” Sometimes the price doesn’t keep going up. Sometimes the stock price just drops. And sometimes, they lose a lot of net worth.
This is my cutting edge in professional development—understanding the psychology of this well-known problem and trying to increase my batting average in helping clients understand the value and prudence of diversifying concentrated stock positions. We have a new approach that is showing some improvement, and I’m grateful for that.
These vignettes show just how complex personal finances can become, often without you realizing it. Whether it’s overlooked stock option transactions, forgotten accounts, or big spending habits that have gone unnoticed, these financial surprises can have substantial impacts on your financial health. As financial planners, our job is not just to plan for the future, but often to uncover and address these hidden issues from the past. If you haven’t reviewed your financial situation lately, it would be worth taking a closer look—you never know what you might discover.
Parkworth Wealth Management provides holistic wealth management services including financial planning, equity compensation planning, investment management, tax planning, and others, on a fee-only basis and as a fiduciary, acting in clients’ best interests. If you’re ready to review your financial situation to uncover any hidden issues from the past, schedule a complimentary consultation.
