Take Company Stock Out Before Moving Your 401(k) Plan Money to an IRA
© Shane Flait (2012)

 

It’s common to rollover your company plan – such as your 401(k) - funds into an IRA or into another company’s plan if you decide to continue working. But whatever you do - don’t rollover any of your company’s stock you bought within your company’s qualified plan. Take advantage of serious tax savings on them by taking them as a distribution while rolling the remainder of your company plan into an IRA.

 

The reason for this is that anything you roll into an IRA will be taxed at your ordinary income tax rate when you eventually withdraw it.  Income tax has the highest tax rates with marginal tax rates going to 35%. If you rollover that company stock it’ll lose its lower tax treatment and be taxed as ordinary income like everything else in your IRA.

 

A good tax break on company stock distributed to you from your 401(k) plan

 

Ask that your company stock that’s part of your company plan be distributed to you so you can benefit by a reduced tax treatment for them – be sure to receive the shares, not their value in cash. You’ll have to pay ordinary income tax on the amount you originally paid for the stock when you bought them within the company plan. That (or those) purchase price(s) after you’ve  paid the income tax on them will then be your ‘basis’ in the stock for when you sell them at some future date – or even right away. But hopefully, the stock’s value has appreciated substantially since you bought them. Here’s the tax break you’ll get…

 

The difference between the stock’s current market value and your new tax basis in them is called the “net unrealized appreciation” (NUA). This NUA is the gain you’ll have if you sell the stock right away. But if you did, you’d be taxed on that gain at the lower ‘long-term’ capital gains rate no matter how long you owned that stock since it’s all treated as being held long term. That’s where the tax break is.

 

You can hold off on selling the stock – perhaps sell it in parts over time. And then you still only pay at the long term capital gain rates. Capital gain tax rates are presently 0 or 15% depending on your marginal income tax bracket being at/under or over 25%, respectively. These advantageous capital gain tax rates will be in effect until the end of 2012.

As an example, suppose an employee buys $50,000 worth of company stock in his 401(k) plan, and it grows to be worth $200,000. If that stock is rolled over to an IRA, it’ll all be taxed as ordinary income at a rate of up to 35 percent when he withdraws it. The $50,000 purchase price means nothing in that case.

If, on the other hand, he takes a distribution of that stock from the plan, he would be taxed at ordinary income tax rates on his original purchase of $50,000 in the year of distribution of shares to him. That may be a chunk of tax money, but, there’s no tax on the $150,000 of stock appreciation (i.e. gain or NUA) until he actually sells any stock! And it can keep on growing too.

And when he does sell it, he’ll be taxed on that gain at the long-term capital-gains rate of only 15 percent – as said above. That’s a lot less tax than paying that $450,000 – or whatever it increases to - at income tax rates later.

 

 

 

 

Shane Flait is a writer and educator. See more at www.EasyRetirementKnowHow.com