Your choices when rolling over a 401(k) containing employer stock
Most commonly, if you are moving a 401(k) either into an IRA we recommend moving the employer stock at the same time (either as stock or liquidated) just as you would with your other investments, and most people chose to do this.
However, for completeness, there is a potential tax treatment that applies to appreciated company stock within a 401(k) that we want you to be aware of, though it does involve paying more tax in the short term. As a rule of thumb, we believe this is worth primarily exploring if you have left your employer and have company stock from that employer within your 401(k) that has appreciated by at least $2,500 (e.g. you paid $10,000 and it's now worth $12,500+), are in high tax bracket for the foreseeable future, likely into retirement, and don't mind dealing with relatively complex tax issues yourself or have a tax accountant.
We use the $2,500 level for employer stock appreciation, though it is somewhat subjective, because the tax benefit is likely to be on the order of 20% of the appreciated value, and so view a $500 tax reduction as a reasonable payoff for the complexity, the loss of the tax shelter on the company stock's value going forward and the need for you to make a short term tax payment as part of the process. You also must have a trigger event, as listed below, for most this will be leaving their employer or reaching 59.5.
This is often referred to as the Net Unrealized Appreciation (NUA) rule. It is important to note that you must be comfortable with and able to pay additional tax in the short term - ordinary income tax on the cost basis of your employee stock. The advantage of doing this is a potential reduction in your overall, long term tax payment because the appreciated portion of company stock would be taxed as a capital gain rather than income and this is a lower tax rate, particularly for those in high income tax brackets.
The disadvantages are the complexity, the need to pay more tax in the short term, and that it would give up the potential for your employer stock to grow tax deferred because it is now in a taxable account. There is also risk that a change to the tax system or your tax bracket could reduce or eliminate the value of this move in future years.
In order to do this at least one of the following trigger events must be met.
- You have separated service from the company who's plan holds the stock
- You have reached age 59.5
- Total disability if you are self employed
If the appropriate conditions are met and the procedures followed, the potential gain is the value of the appreciated portion of the stock in the range of 10% to 24.6% depending on your tax bracket assuming you meet all the other criteria, the potential gain increases with higher tax brackets as the difference between the tax rate on income and capital gains increases.
In order to do this we will keep your employer stock in-kind (i.e. keep it intact as stock, not move it into cash or anything else) and transfer it into a taxable account, we must also rollover your 401(k) at the same time (technically in a year but we do it simultaneously), to a tax-advantaged account to qualify. If only the employer stock moves but the rest of the 401(k) does not, the tax opportunity does not apply even though they are going into different accounts. You will pay income tax on the cost basis on the employer stock and capital gains on the appreciated portion of the stock once sold, but assuming you meet the criteria above your overall tax burden should be lower, though note that income tax on the cost basis of the stock may be a significant cash expense. Please note that we are willing to make this change on your behalf, but you must be sure that you meet the criteria.
-Simon Moore, CFA
Some additional information on this subject is also available on the Fidelity website:
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