Those with company stock in their 401(k) may be able to take advantage of a little known tax strategy called Net Unrealized Appreciation (NUA).
While it varies by plan, usually once you are retired, you are eligible to take an in kind distribution of the employer stock from the 401(k). You are taxed at ordinary income rates on what you paid for the stock in the year of distribution and the appreciation can mostly be realized at long-term capital gain rates when sold.
Example – A 401(k) worth $750,000
- In the 401(k) you have $300,000 in company stock that you bought for $50,000.
- The other $450,000 is in other investment funds.
- Your ordinary income marginal tax rate will drop to 24% federal and 5% state in retirement.
- Your capital gains tax rate will be 15% federal and 5% state in retirement.
With NUA - $64,500 in estimated taxes
- Distribute the $300,000 of company stock in kind to an investment account
- Pay 24% + 5% tax on $50,000 (cost basis) = $14,500 tax
- Sell stock over time and pay 15% + 5% tax on $250,000 (capital gains) = $50,000 tax
- assumes no further appreciation after distribution and avoided Medicare tax
Without NUA - $87,000 in estimated taxes
- Distribute the $300,000 over several years directly from the 401(k)
- Pay 24% + 5% tax on $300,000 = $87,000 tax
Disclaimer: Alex Voorhees and Reston Wealth Management do not provide legal, accounting or tax advice. This information is not intended to be a substitute for specific individualized tax or legal advice. We suggest that you discuss your specific situation with a qualified tax or legal advisor.
All examples or estimated numbers are hypothetical in nature and solely used for illustrative purposes. The opinions voiced in this article are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) or strategies may be appropriate for you, consult your financial advisor prior to investing. No strategy assures success or protects against loss.
You should also consider whether or not it is prudent to have a large amount of your 401(k) in one company. This largely depends on your risk tolerance, your overall net worth, and your financial goals.
Different 401(k) plans have their own rules so be sure to talk to your plan administrator, accountant, and financial advisor before starting. Some plans require complete distribution when making a company stock distribution. Not all gains are taxed at long-term capital gains rates depending on the length the stock was held after distribution from the 401(k).