Company Stock Could Be Taxing Your IRA

Americans hate paying taxes on their hard-earned income. This sentiment is one of the reasons that tax-deferred retirement savings plans, such as 401(k) plans, have become so popular.

There is no question a 401(k) is a great way to save for retirement. And with the baby boomer generation closing in on retirement age and people increasingly changing jobs these days, plenty of workers are faced with decisions about what to do with 401(k) holdings from old jobs.

Making investment decisions strictly on the basis of tax deferment, however, isn't always the best strategy. When you have your employer's stock in a qualified retirement plan, there is a little-known tax play you'll want to check out when you decide to retire or leave your company.

Company stock is given special tax treatment when it's time for distribution. Its increased value qualifies for capital gains taxation, rather than ordinary income, if you don't roll it into an IRA. So if you plan to roll your 401(k) into an IRA, you may want to actually take your company stock separately.

You will only have to pay ordinary tax on your original cost basis. For instance, if you have $50,000 worth of company stock in your 401(k) and the original investment was $15,000, you will pay tax on $15,000 when you take it out. The tax will be at your regular tax rate.

Regardless of how long you hold the stock, you will pay tax on the remaining balance at the long-term capital gains rate of 15%. You do not have to hold it for the usual 12 months to qualify it for the long-term capital gains rate. Regardless of how long the stock was in your 401(k) -- even if only for a day -- the price buildup qualifies for the more favorable 15% capital gains tax rate. The IRS calls this kind of situation net unrealized appreciation -- NUA.