Do you own company stock in a 401(k) or other workplace retirement savings plan like the 2 million Fidelity customers do?
If so, you should be aware of a tax break that, if you qualify, could result in significant savings.
The distribution of company stock is an eventual decision that every owner must make, usually upon retirement or changing jobs. Utilizing net unrealized appreciation (NUA), a little-known tax benefit, may be able to reduce your tax burden if you decide to take a distribution.
You’ll have to decide whether to pay capital gains taxes or regular income taxes on appreciated company stock. Ordinary income taxes—you will eventually have to pay on the gains from your company stock holdings,” says Fidelity Investments vice president and financial consultant Mitch Pomerance.
Pomerance explains, “With NUA, you can effectively pay lower capital gains rates on a portion of your tax-deferred assets instead of paying the typically higher ordinary income rates when assets are withdrawn from the tax-deferred account when you have company stock in your qualified retirement plan, such as your 401(k), and take a lump-sum distribution from a qualified retirement plan.”
The numeric difference (NUA) between a stock’s cost basis, or the price you paid when you first purchased it, and its market value today Let’s say you have $20 per share of company stock in your plan, and you use $2,000 to buy 100 shares. Five years later, the shares are valued at $35 apiece, for a total of $3,500; your cost basis would be $2,000 of that amount, and NUA would be $1,500.
When it comes to rolling over company stock or its cash value out of your 401(k) plan, you have two options: either distribute the company stock into a taxable account and roll over the remaining assets into an IRA or 401(k) plan, or roll the company stock into an IRA (or another 401(k) plan). This is why NUA matters. Depending on your situation, the latter choice may be more advantageous due to IRS regulations governing NUA.
The majority of asset transfers from 401(k) plans to taxable accounts are subject to income tax on the market value of the transferred assets. However, you only pay income tax on the stock’s cost basis when you own company stock—not on the appreciation since you purchased it. (If you are under the age of twenty-five percent, you may also be required to pay an early withdrawal penalty of 2010 percent.) (Remember that the unique NUA tax benefits for company stock are forfeited upon a direct, in-kind transfer to an IRA.) Note: Leaving the company stock assets in the 401(k) without a rollover or distribution could also be an option.
You will pay any additional capital gains that arise after you make the distribution, in addition to long-term capital gains tax on the stocks NUA, when you sell your shares. The current federal capital gains tax rate is 2020%, which is significantly lower than the current rate of 237% on the top income, so you could be able to save a significant amount of money on taxes. (Note also that the top income rate currently in effect is anticipated to reset to 39 when the Tax Cuts and Jobs Act of 2017 expires in 2026. 6%. ).
According to Pomerance, “it may make sense to take the tax hit now rather than later on the full amount if the cost basis is low, relative to the size of the stock position in your 401(k).”
Yes, you can transfer stock to a 401(k) under certain circumstances. This process is known as a rollover, and it allows you to move assets from one retirement account to another without incurring any tax penalties. However, there are specific rules and limitations that you need to be aware of before initiating a stock transfer to your 401(k).
Eligibility for Stock Transfer to 401(k)
The following conditions must be met for a stock transfer to a 401(k) to be considered a valid rollover:
- The stock must be held in a qualified retirement account. This includes employer-sponsored plans like 401(k)s, 403(b)s, and 457(b)s, as well as individual retirement accounts (IRAs).
- The 401(k) you are transferring the stock to must accept rollovers. Not all 401(k) plans allow rollovers, so it’s essential to check with your plan administrator before proceeding.
- You must follow the specific rollover procedures outlined by the IRS. This typically involves completing a direct transfer of the stock from the old account to the new account.
Types of Stock Transfers to 401(k)
There are two main types of stock transfers to 401(k)s:
- Direct rollover: This is the most common type of rollover, where the stock is transferred directly from the old account to the new account without you ever taking possession of it. This is the safest and most tax-efficient way to transfer stock to a 401(k).
- Indirect rollover: In an indirect rollover, you receive the stock distribution from the old account and then deposit it into the new account within 60 days. This method carries a higher risk of tax penalties if you fail to meet the 60-day deadline.
Tax Implications of Stock Transfers to 401(k)
When you transfer stock to a 401(k), the transaction is generally not considered a taxable event. This means you won’t have to pay any taxes on the capital gains associated with the stock until you withdraw it from the 401(k) in retirement.
However, there are a few exceptions to this rule:
- If you receive a direct rollover and then cash out the stock before depositing it into the new 401(k), you will be subject to income taxes and potential early withdrawal penalties.
- If you transfer stock that has unrealized capital losses, you won’t be able to deduct those losses on your tax return.
Advantages of Transferring Stock to a 401(k)
There are several potential advantages to transferring stock to a 401(k):
- Tax-deferred growth: Your stock will continue to grow tax-free within the 401(k) until you withdraw it in retirement.
- Potential diversification: You can diversify your 401(k) portfolio by adding different types of assets, including stocks.
- Reduced risk of penalties: By transferring stock directly to your 401(k), you avoid the risk of incurring early withdrawal penalties if you were to cash out the stock before age 59 1/2.
Disadvantages of Transferring Stock to a 401(k)
There are also a few potential disadvantages to consider:
- Limited investment options: Some 401(k) plans have limited investment options, which could restrict your ability to choose the specific stocks you want to hold.
- Early withdrawal penalties: If you need to withdraw the stock from your 401(k) before age 59 1/2, you may be subject to a 10% early withdrawal penalty, in addition to your regular income tax rate.
- Loss of control: Once you transfer stock to your 401(k), you will no longer have direct control over how it is managed.
Transferring stock to a 401(k) can be a beneficial strategy for investors who want to diversify their retirement portfolio and benefit from tax-deferred growth. However, it’s crucial to understand the eligibility requirements, tax implications, and potential drawbacks before making a decision. Consulting with a financial advisor can help you determine if transferring stock to a 401(k) is the right choice for your individual circumstances.
FAQs
Can I transfer stock from my brokerage account to a 401(k)?
No, you cannot directly transfer stock from a brokerage account to a 401(k). To transfer stock to a 401(k), it must be held in a qualified retirement account.
Can I transfer stock from an IRA to a 401(k)?
Yes, you can transfer stock from an IRA to a 401(k) if the 401(k) plan allows rollovers. However, you may be subject to taxes and penalties if you withdraw the stock from the IRA before age 59 1/2.
What happens to the cost basis of stock when it is transferred to a 401(k)?
The cost basis of stock remains the same when it is transferred to a 401(k). This means that when you eventually withdraw the stock from the 401(k), you will only pay taxes on the capital gains that have accrued since the transfer date.
Can I transfer stock to a Roth 401(k)?
Yes, you can transfer stock to a Roth 401(k) if the plan allows rollovers. However, you will need to pay taxes on any capital gains associated with the stock at the time of the transfer.
4 things you may not know about 529 plans
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Do you own company stock in a 401(k) or other workplace retirement savings plan like the 2 million Fidelity customers do?
If so, you should be aware of a tax break that, if you qualify, could result in significant savings.
The distribution of company stock is an eventual decision that every owner must make, usually upon retirement or changing jobs. Utilizing net unrealized appreciation (NUA), a little-known tax benefit, may be able to reduce your tax burden if you decide to take a distribution.
You’ll have to decide whether to pay capital gains taxes or regular income taxes on appreciated company stock. Ordinary income taxes—you will eventually have to pay on the gains from your company stock holdings,” says Fidelity Investments vice president and financial consultant Mitch Pomerance.
Pomerance explains, “With NUA, you can effectively pay lower capital gains rates on a portion of your tax-deferred assets instead of paying the typically higher ordinary income rates when assets are withdrawn from the tax-deferred account when you have company stock in your qualified retirement plan, such as your 401(k), and take a lump-sum distribution from a qualified retirement plan.”
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The numeric difference (NUA) between a stock’s cost basis, or the price you paid when you first purchased it, and its market value today Let’s say you have $20 per share of company stock in your plan, and you use $2,000 to buy 100 shares. Five years later, the shares are valued at $35 apiece, for a total of $3,500; your cost basis would be $2,000 of that amount, and NUA would be $1,500.
When it comes to rolling over company stock or its cash value out of your 401(k) plan, you have two options: either distribute the company stock into a taxable account and roll over the remaining assets into an IRA or 401(k) plan, or roll the company stock into an IRA (or another 401(k) plan). This is why NUA matters. Depending on your situation, the latter choice may be more advantageous due to IRS regulations governing NUA.
The majority of asset transfers from 401(k) plans to taxable accounts are subject to income tax on the market value of the transferred assets. However, you only pay income tax on the stock’s cost basis when you own company stock—not on the appreciation since you purchased it. (If you are under the age of twenty-five percent, you may also be required to pay an early withdrawal penalty of 2010 percent.) (Remember that the unique NUA tax benefits for company stock are forfeited upon a direct, in-kind transfer to an IRA.) Note: Leaving the company stock assets in the 401(k) without a rollover or distribution could also be an option.
You will pay any additional capital gains that arise after you make the distribution, in addition to long-term capital gains tax on the stocks NUA, when you sell your shares. The current federal capital gains tax rate is 2020%, which is significantly lower than the current rate of 237% on the top income, so you could be able to save a significant amount of money on taxes. (Note also that the top income rate currently in effect is anticipated to reset to 39 when the Tax Cuts and Jobs Act of 2017 expires in 2026. 6%. ).
According to Pomerance, “it may make sense to take the tax hit now rather than later on the full amount if the cost basis is low, relative to the size of the stock position in your 401(k).”
Scenario 2: Don’t utilize an NUA approach because taxes are estimated to be lower in the future
In other cases, however, the investor might be better off rolling the company stock straight into an IRA rather than completing a NUA because their retirement income might be significantly less than their current level and the effective ordinary income tax rate might be lower.
In the following hypothetical scenario, consider Irwin, age 65. He has a long history in biotechnology as a senior executive earning approximately $500k annually, which places him in the estimated federal tax bracket of $535,000.
He recently retired from a single company with a 401(k) plan worth $2,500,000, of which $500,000 was invested in business stock. NUA is $250,000. Irwin is at the top of his earning potential, enjoys what he does, and will probably work for another five years after leaving his current position and company this year, even though that’s a nice nest egg.
In a few years, Irwin would retire at age 70 and have projected retirement benefits (RDDs) of roughly $162,000 at age 73. That ought to place him in the 2022–2023 federal tax bracket as opposed to his current tax bracket of 35%.
If Irwin had exercised NUA, his situation would have placed him in a bracket today and increased the amount of taxes that would need to be paid on NUA. Therefore, considering his high current income and the likelihood that his tax bracket will drop in the future, NUA makes no sense.
| Not utilizing NUA | |
|---|---|
| Value of Irwins 401(k) | $2,500,000 |
| Value of company stock | $500,000 |
| NUA level | $250,000 |
| Estimated tax bracket if not exercising NUA | 35% |
| Estimated tax bracket if exercising NUA | 37% |
| Estimated first year taxes on NUA | $92,500 |
| Hypothetical taxes on the same amount taken through RMDs over the course of Irwins retirement at the 22% rate | $55,000 |
| For illustrative purposes only. State and local taxes are not considered. Estimates are based on the subject filing taxes with the IRS as “Married and filing jointly.” No further contributions are considered. Estimated rate of growth on company stock is assumed to be 7%. |