Employees who are approaching retirement or taking advantage of a buyout and who hold company stock in a 401(k) should consider potential tax savings from taking a lump-sum distribution of the stock into a taxable brokerage account rather than rolling it into an IRA, USAToday says. The employee pays tax at the time of the distribution, based on his or her normal tax rate (25 percent or more) on the cost basis in the stock, not on its fair market value. When the stock is eventually sold, the employee will pay 15% long-term capital gains tax on the net unrealized appreciation (NUA), the difference between the original cost of the stock and the current value.
Several rules apply to this tax strategy, FPA Journal says, including:
- All other assets of the 401(k) should be rolled into an IRA so that the balance in the account at the end of the tax year is zero.
- There should be a “triggering event” for the distribution, such as the employee reaching age 59 1-2 or separation from his or her company.
- A 10 percent early withdrawal penalty will apply if the employee has not reached age 55, but the strategy may still be beneficial if the stock has increased in value.
- Net unrealized appreciation on shares purchased with after-tax employee contributions is also eligible for the NUA strategy.
Employees may put some of their company stock into an IRA and some in a taxable account, depending on their basis or on what they plan to do with the proceeds of the stock. An individual may wish to purchase a retirement home within the first year with the proceeds of the sale of some of the stock and will chose the taxable account option and pay the 15 percent capital gains tax. Moving the stock into an IRA may make more sense if the employee plans to keep it as part of an estate, FPA Journal reports.
The strategy doesn’t work if the employee has had minimal gains or has lost money in company stock, USAToday says. It may not be used if the stock was sold while it was in the 401(k).
Rebalancing a portfolio in a 401(k) may entail selling company stock, but it is a good idea, says the Washington Post. Rebalancing, which is a strategy 401(k) investors should adopt, forces the investor to sell high and buy low, something that many people find difficult to do.
Another investment strategy 401(k) participants should follow is diversification, according to the Post, and this means not holding too much company stock in a 401(k) or in an IRA, even when the company is doing well, as the memory of devasted Enron employees should remind investors. Again, this means selling company stock when it is doing well, and using the proceeds to invest in bonds or other asset classes.
Enron employees were not allowed to sell stock they received as matches, a provision that Congress has made illegal the Post says. But Congress refused to limit the percentage of company stock an employee could hold in his or her retirement account to 20 percent, as former Senator Jon Corzine recommended.
According to the most recent Employee Benefit Research Institute (EBRI) survey, the Post reports, 41 percent of 401(k) participants had more than 20 percent of their assets in company stock and 11 percent had 80 percent or more. “A diversified portfolio can be the difference between working forever and being able to retire,” says Dallas Salisbury, president of EBRI, according to the Post.
Above all, the Post says, don’t check the 100 percent company stock on a 401(k) form.