How to Make the Most of Company Stock in Your 401(k)

If you happen to own company stock in your 401(k) there’s a little-known strategy that could help you reduce your tax bill when taking a lump-sum distribution from your company’s qualified retirement plan.
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If you happen to own company stock in your 401(k) there’s a little-known strategy that could help you reduce your tax bill when taking a lump-sum distribution from your company’s qualified retirement plan.

In a video interview with Retirement Daily, Dana Anspach, CFP, RMA, the founder of Sensible Money and author of The Great Courses How to Plan for the Perfect Retirement, Control Your Retirement Destiny, and Social Security Sense, explained how the strategy, which is known as net unrealized appreciation or NUA, works, who should consider it and how to know if it will benefit you.

In essence, it works like this: When taking a lump-sum distribution from your retirement plan due to a triggering event such as retirement or turning 59½ or a disability, the cost basis of the shares will be taxed as ordinary income, and the difference between the cost basis and the stock’s price before it’s sold is called the NUA.

And when the stock is sold, the NUA will be taxed, assuming there’s a gain, typically at long-term capital gains rates, which can be lower than ordinary income tax rates. Not using the net realized appreciation means the lump-sum distribution would be taxed at less preferential ordinary income tax rates, or if rolling the money into an IRA, taxed as ordinary income when distributed.

Ultimately, taking advantage of NUA can result in some big tax planning opportunities. “You are lowering your required minimum distributions later, and you may also be creating an opportunity where you can do more Roth conversions,” said Anspach.

Anspach also outlined some of the factors to weigh when evaluating whether using the NUA strategy is beneficial.

  • Your ordinary income tax rate throughout retirement compared to the long-term capital gains tax rate. “You want to look at (your) ordinary income tax rate now and what it's likely to be throughout retirement,” said Anspach.
  • The amount of assets you have inside tax-deferred retirement plans versus investments in brokerage accounts and mutual funds held outside the retirement account wrapper.
  • The potential impact on other planning opportunities such as Roth conversions, delaying Social Security and means-testing for Medicare Part B and D premiums.

In the video interview, Anspach provided several examples of clients who had the opportunity to use NUA and detailed the process used to determine if the strategy would be beneficial.

Additional reading

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