When you retire, you're frequently informed to roll-over your retirement plan assets - like your 401(k) funds into an IRA or into another company's qualified plan in the event you decide to continue working. But what ever you do - don't roll over any of your employer's stock you purchased within the company's retirement plan without checking for the following tax break. There's a major tax break in the event you follow the advice in this post and that is because employer shares gets a reduced tax treatment that could benefit you by tens of thousands of dollars.
Everything you roll into an Individual Retirement Arrangement will be taxed at your normal income tax rate once you withdraw it. Normal income tax has the greatest tax rates with marginal tax rates going to 35%. In the event you roll over those employer shares, you will pay the same onerous rate as you do on other IRA assets upon withdraw. So consider NOT rolling over shares held in your employer's company.
The difference between the stock's present market value when you retire and your tax basis in them (the amount you originally paid) is your profit. IRS calls this 'net unrealized appreciation' (NUA). This NUA is the profit you will have in the event you sold the stock immediately. In case you did, you'd be taxed on the gain at the reduced 'long-term' capital gains rate in spite of how long you owned the shares. Therefore, the tax break on the gain could be the difference between paying tax at 35% vs 15% (the current tax rate on capital gains).
If you have a large NUA, ask that company shares be dispersed to you for the advantage of the special tax breaks that IRS offers on employer stock. You will have to pay normal income tax on the amount you originally paid for the stock in the company strategy when you get those shares. The original price you paid for the shares and on which you will pay tax today will then be your tax 'basis' in the stock. But you wont have to pay any tax now on the NUA as long as you hold onto your shares (outside of your rollover IRA).
You may hold off on selling the shares - maybe sell it in parts over time if you need the money. And when you do sell, you only pay at the long-term capital gain rates. Capital gain tax rates are presently (in 2012) 0% or 15% based on your marginal income tax bracket.
For example, suppose a worker buys $25,000 worth of employer stock in his 401(k) plan, and it appreciates in value over the years to be worth $250,000. If that stock is rolled over to an IRA, it'll be taxed as ordinary income at a rate of as much as 35 % when the stock is eventually sold and the proceeds taken out of the IRA. No tax breaks there.
If, on the other hand, our taxpayer takes possession of that stock from the 401k when he retires or leave the company, he would be taxed at ordinary income tax rates on his initial purchase of $25,000 in the yr of distribution. But, there's no present tax on the $225,000 of stock appreciation (i.e. gain or NUA) until he sells any of the shares! And when he does sell shares, he'll be taxed on that gain at the long-term capital-gains rate of only 15 percent (presuming Congress does not change the rate).
Tax breaks when making the right moves with your retirement accounts can be substantial.
Lose a Fortune on Your 401k Rollover
If you do not do any of these correctly:
- Opt for a distribution rather than direct transfer
- Rollover company stock to an IRA
- Choose to rollover to a Roth IRA
- Rollover to your new employer’s 401k
- Rollover post-tax contributions