If you own your employer’s stock in your 401(k) plan and the stock has increased significantly in value, there is a tax strategy that can potentially reduce the amount of taxes you pay when you distribute the stock from your plan. We will discuss this strategy today, and explain when it might be appropriate to use.
By Brandon Baiamonte, MS, CPA, CFE, CFM
Mission Wealth Director of Tax Strategy
Some of us are able to purchase or receive stock in the company we work for as one of our 401(k) investment choices. The difference between what we purchased the stock for and what it is currently worth is sometimes referred to as net unrealized appreciation or NUA.
When we make a taxable distribution from our 401(k) plan we generally pay taxes on the entire distribution at ordinary income tax rates. These rates can be as high as 37%. Under certain circumstances with employer stock, we only need to pay ordinary income taxes on what we purchased the stock for – our cost basis. The gains or NUA are then taxed at the lower long-term capital gains rate whenever we choose to sell it. The maximum capital gains rate is 20%, which is substantially lower than the highest ordinary income tax rate of 37%.
There are a few conditions that must be met in order to use this strategy. Watch the video or continue reading to learn about each.
In-Kind Distribution of Stock
You must transfer the stock directly from your 401(k) plan to a taxable brokerage account. You can’t sell the stock in your 401(k), and then repurchase it in your taxable account. You also can’t rollover your employer stock into an IRA, and then make the decision to distribute to a taxable account later on.
Lump-Sum Distribution
You must distribute your entire 401(k) balance within one tax year. You would generally need to make two different transfers. You would open up a taxable brokerage account and transfer your employer stock into it. You would then rollover the remainder of your 401(k) account into an IRA. You want to ensure your 401(k) balance is zero at the end of the year. Even a small balance in your 401(k) can be a problem.
It should be noted you don’t need to distribute all of your company stock into a taxable account. You could transfer a portion of your employer stock into a taxable account, and then rollover the remainder (with all your other investments) into an IRA. It might make sense to only distribute your lowest basis shares to the taxable account.
Triggering Event
There are four triggering events that enable you to use this strategy.
They are:
a. Death
b. Disability
c. Reaching age 59 ½
d. Separation from service with employer
Should you use this strategy? Well, it depends.
This strategy works best when the current value of the stock is significantly higher than what you paid for it. You’ll also want to look at the tax bracket you are in now, and compare to the likely tax bracket you’ll be in when you make distributions from your 401(k) plan or IRA.
This strategy might seem complicated, but can reduce your taxes significantly in some circumstances.
How Mission Wealth Can Help
At Mission Wealth, we integrate tax planning with your overall financial picture to help you reach your goals. We help you explore the most cost-effective solutions to help cover a number of possibilities. We have no proprietary products to sell and no quotas to fill. We simply offer independent, objective advice that serves your best interests.
Our Tax Management Services Include:
- Estate Tax Reduction Strategies
- Annual Tax Management Review (for Integrated Wealth and Private Clients)
- Concentrated Stock Planning (Access to LPs)
- Integration & Coordination with CPA on Tax Savings Strategies
Your client advisor at Mission Wealth is available to help coordinate with your tax advisor and is a great resource to help plan for and implement this and other strategies. If you don’t have an advisor but would like to learn more, you can contact us by phone or the Contact Us form below and an advisor will be in touch.
MISSION WEALTH IS A REGISTERED INVESTMENT ADVISER. THIS DOCUMENT IS SOLELY FOR INFORMATIONAL PURPOSES, NO INVESTMENTS ARE RECOMMENDED. ADVISORY SERVICES ARE ONLY OFFERED TO CLIENTS OR PROSPECTIVE CLIENTS WHERE MISSION WEALTH AND ITS REPRESENTATIVES ARE PROPERLY LICENSED OR EXEMPT FROM LICENSURE. NO ADVICE MAY BE RENDERED BY MISSION WEALTH UNLESS A CLIENT SERVICE AGREEMENT IS IN PLACE.
00421705 12/21
Mission Wealth is a Registered Investment Adviser. This commentary reflects the personal opinions, viewpoints, and analyses of the Mission Wealth employees providing such comments. It should not be regarded as a description of advisory services provided by Mission Wealth or performance returns of any Mission Wealth client. The views reflected in the commentary are subject to change at any time without notice. Nothing in this commentary constitutes investment advice, performance data, or any recommendation that any particular security, portfolio of securities, transaction, or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Mission Wealth manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.
