Do you have the courage of your convictions? If you do, you may have invested heavily in company stock through your 401(k) plan. Should the stock take off, you could be in line for an unprecedented payoff.
Strategy: When you’re ready to retire, keep the payout in the form of company stock. Don’t convert it to cash or other securities.
Due to a special tax law provision, you only have to pay current federal income tax on the plan’s original cost for the stock. In other words, there’s no current tax due on the appreciation in value—called the “net unrealized appreciation” (NUA)—that occurred before you received the stock from the plan. Instead, the NUA plus any future appreciation goes untaxed until you sell the shares.
Icing on the cake: Any subsequent gain from selling the stock is treated as long-term capital gain as long as you’ve held it for more than one year. The maximum tax rate on long-term capital gain is 20% compared to the top ordinary income tax rate of 39.6%. So you’re a double tax winner: Once when you leave the company and again when you sell the stock.
To qualify for these tax breaks, the distribution of stock must meet three requirements.
- It must be from a qualified retirement plan such as a 401(k), pension or profit-sharing or stock bonus plan. IRAs do not qualify.
- It must be due to death; reaching age 59½; or separation from service.
- It must be received as a lump-sum distribution in one tax year.
For example, if you take a lump-sum distribution of the full plan balance before the end of the year and the company adds a late contribution or makes some other adjustment, the distribution may lose its status as a lump-sum payout.
Alternatively, you can choose to roll over company stock into an IRA. But then your future distributions from the IRA will be taxed at ordinary income rates.
Tip: Also, you must begin taking required minimum distributions (RMDs) from an IRA after age 70½.