If you have employer stock in your company retirement plan, there are some special tax benefits that you’ll lose if you put that stock into an IRA.
Generally, when you leave your employer you’ll roll your retirement account out to an IRA. Once you’ve passed age 59½ you can take distributions from the IRA with no tax penalty, but all distributions are taxable at ordinary income rates.
Net Unrealized Appreciation
But there’s a special provision for employer stock. You can distribute the stock from your retirement plan in kind, moving it to a non-tax qualified brokerage account. You will have an immediate taxable event in the amout of the stock’s cost basis. Then when you sell the stock you’ll be taxed only on the gain over the basis, and at the more favorable long-term capital gains rates.
This is a huge tax benefit — but it is a case of a little pain now for a great gain later.
Important: This NUA treatment is only available as part of a qualifying lump-sum distribution — meaning the entire balance of the plan must be distributed within a single tax year. The triggering events that qualify are: separation from service, reaching age 59½, death, or disability (for self-employed only). A partial distribution does not qualify for NUA treatment.
Here’s an example: Say you have a $500K 401K, of which $100K is company stock. That’s the market value of the stock — but the cost basis of the stock is only $20K. That means the market price of the stock as it was contributed to the 401K over the years was only $20K — the remaining $80K comes from growth.
You open an individual brokerage account and transfer the $100K of company stock there in kind. The taxable event to you is the $20K in basis. If you’re in a 24% bracket, you’ll pay $4,800 in taxes on the distribution. The remaining $400K in the account gets rolled over to an IRA. When you sell stock from the individual account, you pay capital gains tax on the gain over the basis. This $80K gain is always long-term, no matter how long the stock has been in your brokerage account. If the stock continues to grow, gains above the $80K will be long-term or short-term depending upon the holding period. For most taxpayers the long-term capital gains rate will be 15%; for some, 0%, and for others, 20%.
Let’s continue the example. You immediately sell the employer stock from your new brokerage account. Your capital gains tax is 15% of $80K, or $12,000. Total tax burden to distribute $100K is $16,800.
BUT . . . if you didn’t do this, and instead rolled the shares into your IRA, and distributed from there, the entire $100K transaction would be taxed at your marginal rate of 24%, or $24,000. Bad move! You could have saved yourself $7,200 in taxes.
This distribution of NUA can be a tremendous tax benefit! If you’re working with an adviser who doesn’t bother to look at your 401K holdings before making any recommendations, or doesn’t suggest you consider the employer stock distribution, you’re working with the wrong adviser!
At CameronDowning we are CERTIFIED FINANCIAL PLANNER™ professionals, meaning we are held to a fiduciary standard of client care. Our advice is given in your best interests, always.
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