If you own a 401(k) that includes stock from your company, chances are you’ll someday need to decide what to do with it. This decision often comes into play for people who are retiring or otherwise leaving their employer. Whatever the case may be for you, it’s important to understand your options when determining whether and how to move company stock out of your 401(k). It’s also worth exploring whether an easily overlooked provision in the U.S. tax code could help you manage your tax bill when the time comes.
What you need to know about IRA rollovers
Many people who leave their employer choose to roll over their entire 401(k) plan account – including all of their company stock – into an IRA. If this transaction is completed in a proper manner, it can be done so with no immediate tax ramifications. However, it’s important to understand that any future withdrawals from the rollover IRA will be taxed at ordinary income tax rates, which can range from 10 percent to 37 percent. And, those who take a taxable distribution prior to age 59-1/2 may face an additional penalty of 10 percent – something that should be taken into serious consideration prior to making such a move.
Capitalizing on net unrealized appreciation rules
Another strategy for moving company stock out of workplace retirement plans that makes sense in many cases, but is often overlooked, involves “net unrealized appreciation” (NUA). NUA represents the difference in value between the average cost basis (in essence, the price initially paid to own the shares of employer stock held in your retirement plan) and the current market value of those shares
Under this strategy, rather than rolling your company stock into an IRA, you separate it from the rest of your 401(k) holdings and take it out as an in-kind distribution. You will owe tax on the cost basis of the stock at your ordinary income tax rate.
However, the appreciated value of the stock (the NUA) will remain untaxed until you liquidate shares of the stock. In that event, you will be taxed at the generally more favorable capital gains tax rate, currently no higher than 15 percent. Dividends will be taxable on an ongoing basis, but possibly at a more favorable “qualified dividends” rate. In certain circumstances, taking a lump-sum distribution of employer stock and invoking NUA provisions could result in a long-term tax-savings.
Importantly, it’s best to wait until you reach age 59-1/2. Completing this transaction prior to that age may incur a 10 percent early withdrawal penalty.
Check your 401(k)
Take a closer look at the assets held in any of your 401(k) plans with both current and past employers. If company stock is included, you may want to consider which strategy – a rollover of the full amount or a lump-sum distribution of employer stock utilizing NUA – is more effective for you. Check with your plan administrator to find out more about the details of the stock position you own. Also consult with your financial and tax advisor to help determine the right approach for your circumstances.
Andrew R. Petty, CRPC®, APMA®, CLTC®, is a Private Wealth Advisor with Nona Wealth Advisors, a private wealth advisory practice of Ameriprise Financial Services, Inc. He offers fee-based financial planning and asset management strategies and has been in practice for 16 years. To contact him, please call 407-249-4006, visit his website at https://www.ameripriseadvisors.com/team/nona-wealth-advisors or stopover at his office at 10917 Dylan Loren Circle, Suite A, Orlando, FL 32825.
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