Why should you distribute shares of company stock from your 401(k) instead of rolling them into an IRA? Many people are fortunate to own shares of company stock in their employer-sponsored retirement plans, including 401(k)’s. Often, these shares have been acquired over many years, and constitute a substantial portion of the overall retirement account balance. Many financial professionals will encourage employees to roll over company shares into an IRA, either during their working years as an in-service distribution, or after retirement. You also have the option of distributing the shares out of your plan. A good advisor will explain the tax implications related to company stock and work with your CPA to calculate how much you stand to gain or lose. You should also review this option any time you change employers during your career, as the potential savings can be significant over the years!
Let’s say you have $300,000 worth of company stock in your 401(k) with an original cost, or basis, of $100,000. The gain in value is referred to as net unrealized appreciation – $200,000 in this example. If you roll the shares into an IRA, when you later sell them and take cash as a distribution it will be taxed as ordinary income. If you distribute the shares from your 401(k) and continue to hold them, the NUA will not be taxed until you sell the shares, and will be taxed as a long-term capital gain. In our example, let’s assume you are in the 28% tax bracket. The potential tax on the $200,000 NUA if you roll the shares into an IRA is 28% of $200,000, or $56,000. If you distribute the shares and hold them, the tax on the $200,000 NUA once you sell the shares is subject to the long-term capital gain rate of 15%, or $30,000. In this example, we have created a savings of $26,000! Once you roll company shares into an IRA there is no way to reverse it, and you lose the opportunity to utilize the NUA strategy.
The potential savings can be significant, especially if you have a substantial NUA and are in a very high tax bracket. Although you are immediately taxed on the amount of the basis on the shares received, the deferred savings can be well worth it. Any gain above and beyond the NUA amount will be treated as short-term or long-term depending on how long you hold the shares after the distribution. Everyone’s situation is different and the tax code is always subject to change, so be sure to consult with your CPA. As always, feel free to contact us with any questions!
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