Uncle’s Stock Gift Could Be Ticket Out of Debt and to New, Part-Time Career
Rose Orrico is 30, divorced, deeply in debt--and sitting on a potential gold mine.
A kindly uncle gave the Glendale bank employee 4,000 restricted shares of his firm, Clarent Corp., an Internet telecommunications company.
But because she is not permitted to sell the shares until Dec. 28, Orrico has been on an emotional roller coaster as the gift’s value dropped to as low as $80,000 and then soared to as high as $440,000. At Monday’s closing price of $90.25, the shares were worth about $361,000.
Orrico hopes that by selling the shares she can pay off the $35,000 she owes on credit cards and other loans while funding a new career as a part-time massage therapist.
“I’m excited to the point of hyperventilating at the thought of being completely debt-free and maybe not working full time ever again,” Orrico wrote to The Times. “These shares are worth more money than I have ever envisioned having ever and I am overwhelmed by it.”
The good news is that Orrico’s dream is possible, assuming the stock price holds up, because she lives comparatively modestly, according to Scott Leonard, a fee-only certified financial planner in Santa Monica who reviewed her situation for The Times.
The windfall would not be enough to allow someone with a higher income to go part time, but Leonard said it could give Orrico, who makes about $36,000 a year, the freedom to do so if she manages her money carefully and does not raise her standard of living.
Those are big “ifs.”
The Silicon Valley company has experienced wild swings in price. Since Clarent went public in July, its stock has ranged from the initial offering price of $15 to more than $100 on several days in November. (Clarent makes software and hardware products that enable rapid voice, fax and data telephony services over intranet or Internet networks.)
Tax Bite
Orrico also must keep in mind that she will lose almost 30% of her gain to federal and state taxes. Because the shares were a gift, she will have to use the price her uncle paid--a half-cent a share, or $20 total--as her tax basis, meaning any gain above that amount will be taxed as profit. But because the shares were purchased more than a year ago, Orrico can qualify for the favorable 20% long-term federal capital gains rate rather than 28%--or higher--federal income tax rates. (Either way, the maximum California income tax rate is 9.3%).
Orrico’s potential windfall has another risk. Orrico admits that she has had significant problems controlling her spending and is currently enrolled in a debt-management plan through a credit counseling company.
“I learned shopping is fun too early in life, before I knew how to manage money,” said Orrico, who owes about $14,000 on her credit cards, $9,000 in personal loans and nearly $12,000 on her car--debts that nearly equal her annual salary of $36,000 as a word processing supervisor.
Even now, she says, she finds herself spending money that she doesn’t have in order to please other people or feel better about herself.
“Money is on my mind constantly. Sometimes I get frustrated that I don’t have enough and spend more than I should on things I don’t need.”
Orrico is definitely at risk of running through her windfall and winding up in debt again if she doesn’t change her spending habits, Leonard said.
“Most people who get large windfalls like an inheritance or winning the lottery are back to where they started after five years,” Leonard said. “You spend and spend and you wake up one day and the money’s gone.”
Leonard recommended that Orrico take $5,000 of her after-tax profit to spend as mad money. The rest should be invested to provide her income so that she can change careers and work part time.
Cost of Living
The planner first asked Orrico to estimate how much she needs to live on--both a low-end figure for when she is attending school and a more realistic amount that includes vacations and a few frills.
Orrico estimated that she could live on as little as $19,000 in after-tax income, a figure that covers her $500-a-month rent, utilities, groceries and basic health insurance, among other costs. To be comfortable, she estimated she would need $30,000 in after-tax income.
Leonard used the former figure to determine how much it would cost Orrico to attend the 12-week massage course she wants to take, and the latter figure for the basis of his calculations on how much Orrico will have to work to supplement the income the invested money would produce. He offered a caveat, however, because Orrico’s income needs are likely to grow in the future, especially if she has children or wants to buy a house.
The $30,000 figure “assumes that she always rents and always stays as she is,” Leonard said. “It doesn’t include buying a new car five years down the road.”
If Orrico’s income needs go up, she will need to work more or risk depleting her invested funds, Leonard said. But if she resists raising her standard of living, even a small windfall would give her some of the flexibility she needs to pursue a new career.
The $30,000 also does not include saving for retirement, and she should remember that her plan for a life of part-time work would mean a small Social Security benefit. But if Orrico gets $90 or more for her shares, she may not need to save much for retirement, especially if her income requirements remain small and she retires at 67, Leonard said. If she wants to retire earlier or have more income in retirement, saving 15% of her working income should give her a comfortable cushion, Leonard said.
Leonard estimated that Orrico could safely tap 6.5% of her invested money without incurring a significant risk of running out of money before she is 100, assuming the money is invested 70% in stocks and 30% in fixed income and cash.
If she nets $214,000 from the stock sale after taxes and other expenses, that would provide her $14,000 a year, a figure that could be adjusted upward each year for inflation. That means Orrico would need to earn at least $16,000 after taxes in her first full year working, Leonard said.
Some experts are more cautious when recommending payout rates. T. Rowe Price, which runs a retirement income estimation service, typically recommends that retirees take no more than 3% to 4% of their money to avoid the risk of running dry. If Orrico took such an approach--4% of the money each year, adjusted for inflation, she would need to earn about $22,000 after taxes.
How much Orrico will make once she finishes her training depends on how much she wants to work and how quickly she can build her practice.
Massage therapists at the Shiatsu Massage School in Santa Monica typically charge $55 to $80 an hour, with the busiest therapists doing about 25 massages a week, said school administrator Jenna Entwistle. Therapists who prefer not to run their own business typically pay about half their hourly fee to the school or spa that provides the space and does their booking, Entwistle said. For example, if Orrico did 10 massages a week at a spa and worked 50 weeks a year, she could make $20,000 before taxes.
First, of course, Orrico will have to decide when to sell the Clarent shares.
The primary question is impossible to answer: When will the price be highest? One consideration is whether large numbers of other restricted shares might be sold on or near Dec. 28, which could temporarily depress the stock price.
Leonard recommended she wait until after Jan. 1 to sell all the shares, to delay the tax bite.
If she sells the shares immediately after the restrictions are removed, she would be forced to pay the tax bill by April 15, 2000, Leonard said.
If she waits until after Dec. 31, she would not have to pay most of the tax until April 15, 2001.
She would avoid underwithholding penalties at that time as long as her withholding and estimated tax payments in 2000 are at least 106% of the amount due for 1999.
The 12-month difference could mean $6,000 in extra money. Assuming she sells the shares at $90, the resulting $100,000-plus tax bill could earn that much if invested at 6%. That money should be invested conservatively to ensure it is available the following April.
Orrico could delay the tax bill still further by exercising only some of the shares in 2000 and the rest in 2001, but Leonard did not think Orrico should take the risk the shares might lose value, and he recommended selling them all at once, and soon.
Orrico, however, was reluctant to sell all the shares. Her original plan was to sell only 1,000 shares to pay for her schooling and other immediate costs, and hang on to the rest to take advantage of future growth.
Leonard warned that for every Microsoft that continues to climb in value year over year, dozens of other high-tech companies see their share prices stagnate or drop--and some even go out of business, leaving their shares worthless.
She would be smarter to sell the shares and diversify into other investments, so that her income and her life plans are not dependent on the fortunes of one stock.
Such risks are better suited to investors who can afford to lose, he said.
“It’s not like she wants to work really hard [earning money at a full-time job] while taking a gamble on the stock. She wants the money to provide income for her, so she needs a very stable portfolio,” Leonard said.
In any case, Orrico said she was thrilled that her plan to leave the corporate world would be possible. She said she is committed to changing her ways and her life to stay out of debt.
“That’s why I wanted to get this advice, to plan it out and organize it so that I don’t” run through the money, Orrico said.
Liz Pulliam is a personal finance writer for The Times and writes the Sunday “Money Talk” column. To be considered for a published Money Make-Over, send your name, age, phone number, income, assets and financial goals to Money Make-Over, Business Section, Los Angeles Times, Times Mirror Square, Los Angeles, CA 90053 or to money@latimes.com. You can save a step and print or download the questionnaire at https://www.latimes.com/makeoverform.
Information on choosing a financial planner is available at The Times’ Web site at https://www.latimes.com/finplan. The site offers stories, phone numbers, addresses and links to related sites.
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The Situation
* Investor: Rose Orrico, 30, at right
* Goal: Decide what to do with restricted stock that may--or may not--be worth about $360,000 in two weeks. Pay off $35,000 in debts, fund a career change and work part time.
* Suggestion: Sell shares after Jan. 1 to delay tax bite, set aside $5,000 in “mad money” and invest the rest.
This Week’s Make-Over
Investor: Rose Orrico, 30, single
Annual income: $36,000
Goals
Use gift of stock to pay off $35,000 in debts, fund a career change and work part time.
Recommendations
* Sell the shares after Jan. 1 to delay tax bite.
* Pay debts and set aside $5,000 in “mad money.” * Invest the rest of the proceeds for income and growth: 5% in cash; 25% in bonds and other fixed-income securities; 70% in equities, divided evenly between U.S. and international.
Meet the Planner
Scott Leonard is a fee-only certified financial planner and principal of Leonard Capital Management in Santa Monica.
