STOP! If You Own Company Stock in your 401(k) You Need to Know About “NUA”
The following is meant to be educational and not specific advice. I assume my readers are big boys/girls and understand that, but in today’s climate I have to tell everyone again anyways – people might do something dumb and go hurt themselves! (like stick a fork in an electric socket or something – don’t do that!). Consult an advisor before attempting tax planning strategies such as the NUA strategy discussed here
Do you own company stock in your 401k? Did you leave your company and are you thinking about rolling that money over into an IRA? If you are in this situation, don’t do anything until you read this article. First a few qualifiying questions:
- Would you like quite favorable tax treatment on the company stock in your 401(k)?
- Would you like to reduce future required minimum distributions on retirement accounts?
- Would you like estate planning advantages?
If you answered yes to any of these, then it’s OK to keep reading!
If you are considering rolling a 401k balance into an IRA, and you own company stock in your 401k, you need to know about the tax rules surrounding net unrealized appreciation (NUA) of stock in a 401k plan. Here’s the benefit that few people know about (from the IRS website: Notice 2009-68):
If you do not do a rollover, you can apply a special rule to payments of employer stock (or other employer securities) that are either attributable to after-tax contributions or paid in a lump sum after separation from service (or after age 591/2, disability, or the participant’s death). Under the special rule, the net unrealized appreciation on the stock will not be taxed when distributed from the Plan and will be taxed at capital gain rates when you sell the stock. Net unrealized appreciation is generally the increase in the value of employer stock after it was acquired by the Plan. If you do a rollover for a payment that includes employer stock (for example, by selling the stock and rolling over the proceeds within 60 days of the payment), the special rule relating to the distributed employer stock will not apply to any subsequent payments from the IRA or employer plan. The Plan administrator can tell you the amount of any net unrealized appreciation.
What is this saying?
It’s saying that if you own company stock in your 401(k) for example, and you follow special rules, there is an option of treating the gains in the stock as capital gains under the tax code as opposed to treating the gains as income, which retirement plan assets are usually treated as no matter the type of investment. Let’s use a short example and set out some facts:
- you work at ABC corporation, a public company
- you have a 401(k) balance with $225,000 and $100,000 of it is in ABC stock (given as part of a profit-sharing plan)
- we’ll assume that you have 10,000 shares priced at $10 each ($100,000).
- We’ll assume an average purchase price of that stock at $2
- Therefore, the average value of the stock when acquired over the years = $20,000 in our example and it grew an additional $80,000 after you received it
What the rule could mean to you, is that if you follow certain SPECIFIC procedures, you can take that stock out of the plan, pay income tax on only the $20,000 cost of acquisition, and pay the capital gains tax rate on the $80,000 “gain” AFTER you sell it (and no one says you have to sell it right away). The tax treatment of company stock in a 401(k) is a hidden bonanza!
What are the benefits to you for doing this?
- lower capital gains taxes on your investment vs higher income taxes (under current law: 15% maximum capital gains rate vs 35% maximum income tax rate)
- no RMD – no required minimum distributions on this money. that’s huge!
- Estate tax advantages – under current step up rules, capital assets are treated much more favorably than retirement accounts after death
If you have the potential to do this, you would benefit from investigating the situation. Here are a few (likely not all) of the things to be aware of:
- rolling the 401k over to an IRA without following the special rules to remove the stock nullifies this benefit
- You have to be prepared to pay the income tax on the “basis amount” (in the above example the 20k) but the benefits could outweigh that temporary cost. Just like converting to a Roth IRA could save a lot of future costs.
- Get professional advice with the maneuver – this can be tricky and messing it up costs too much and the IRS doesn’t usually give mulligans
If you are in this situation, I recommend again seeking professional advice, from say a firm like ours! (enter commercial). We have a good team and network of professionals in the tax, legal, and planning fields with the expertise to help on these matters. If you’d like to talk to someone about this, give us a call at 781.393.0021 or use our contact and comment form below.
Thanks for reading! Read my disclaimer here please – this is an educational article and not meant to be advice directly to you. I don’t know you (yet). consult an advisor before doing anything ok?
For further reading, consider:
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