Immediately rolling over your company retirement plan could cost you significant tax savings, particularly if you worked at one employer most of your career and your retirement plan was at least partially funded with employer stock. Before you retire, consider a special IRS provision which allows you to withdraw company stock while paying income tax on the plan’s cost basis only. When you ultimately sell the stock, you’ll pay the more beneficial capital gains rates rather than ordinary income taxes.
Here is an example of how it might work:
You retire and take a lump-sum distribution of your 401k account which contains $500,000 of employer stock. Over the course of your career, you paid $100,000 for the stock which is now your basis. The Net Unrealized Appreciation (NUA) is the difference between the current value of $500,000 and the basis of $100,000, so $400,000 is the NUA.
Rather than rolling over the entire amount to your IRA, you elect to take a distribution of employer stock. You would now owe:
- Income taxes on the $100,000 of basis.
- Capital gains taxes, when you sell, on the NUA.
If we assume you pay 30% on income but only 15% capital gains you end up reducing, by half, the amount you’ll pay in taxes.
But what about holding all that employer stock? Isn’t it wise to diversify?
Everyone’s situation is different. We’ve had cases where a client with a small account elected to use the NUA strategy while another with a much larger account decided it was best to continue deferring taxes. What will be best for you will depend on your unique circumstances.
There are also ways to combine this with other income tax reduction strategies to reduce or entirely eliminate the marginal tax impact. These may be worth exploring in your particular situation.