Tax Strategy for 401(k) Holding Company Stock

About 24 million Americans hold company stock in 401(k) or other company sponsored retirement plans. Many of these individuals, when they retire, could take advantage of a little-known tax break know as net unrealized appreciation. Here is how it works:

First, after you leave your job, you withdraw your company stock from the company plan and move it into a taxable brokerage account. Second, during the same calendar year, you withdraw the rest of your assets from the company plan, as well. Most people move the balance into an individual retirement account to continue the tax deferral on that portion.

By taking these two steps any increase in the price of the company stock from the time you acquired it until the distribution - called the stock's net unrealized appreciation, or NUA - would be subject only to long-term capital-gains tax, which has a maximum 15% rate, rather than ordinary income tax of up to 35%. Ordinary income tax is what you pay on 401(k) or traditional IRA withdrawals. Alternatively, if you leave your company stock in your 401(k), or roll it over into an IRA, you could wind up paying higher income tax when you take it out. There are some up front taxes but you don't owe the capital-gains tax until you sell the shares.

For example: let's say that you bought 100 shares of company stock for $20 a share in your 401(k) plan. When you retire the shares are worth $35, bringing the total market value to $3500. You move the stock to a taxable brokerage account meaning that you owe income tax on the $2000 cost basis. But you can defer the capital-gains tax on the $1500 market appreciation until you sell the stock.

There are some other caveats. Give us a call and we can explore more fully if the NUA option is right for you.