Do you have employer stock sitting in your current 401(k)? Have you left behind an old 401(k) that holds your ex-employer’s stock? Pay attention. The window could be closing on a chance to save a lot of taxes on the appreciation of those shares.
Whereas most withdrawals from a pretax 401(k) are taxed as ordinary income, at a current top rate of 39.6%, appreciation on employer stock can be taxed as capital gain, at a top rate of just 20%. Financial advisors call this the “net unrealized appreciation,” or NUA break. To use it, you move the stock out of the 401(k) into a regular taxable brokerage account, at which point you pay taxes at the ordinary rate on only the stock’s initial value when it was put into the 401(k). You can then hold the shares as long as you like, paying capital gains taxes on appreciation only when you sell.
Why the rush to grab NUA now? The percentage of employers offering company stock in their 401(k) plans has been gradually declining since the implosion of Enron in 2001. But the trend accelerated after the Supreme Court last year rejected the presumption that it’s prudent for an employer to offer its own stock, raising the legal risk to those companies that continue to do so. A March survey by Towers Watson found a quarter of employers that still offered stock were planning to eliminate it or considering doing so. Even cable giant Comcast, whose founder, Ralph Roberts, was a true believer in employee stock ownership, just notified workers it is banishing company stock from its 401(k) effective Jan. 1, 2017.
Typically, if 401(k) participants don’t get rid of their company shares by such a deadline, their holdings are liquidated for them, with the money put in the plan’s default investment option–usually a “target date” mutual fund where the asset allocation is based on your age.
If you’ve left a 401(k) with company stock at a former employer–and some workers purposely leave these behind to preserve the NUA break–now might be the time to act. At the least, watch closely for notices from the plan. (Any additional appreciation after you move the shares out of the retirement plan is subject to the 3.8% Net Investment Income T ax, which hits couples with more than $250,000 in income and singles above $200,000. Appreciation before you move isn’t subject to that tax, so there is some advantage in not rolling the shares until you have to.)
If your plan has good records, you can even cherry-pick, moving only the most highly appreciated shares into a nonretirement account, says Chris Zander, a partner with Evercore Wealth Management in New York. You’ll owe ordinary income taxes–and, if you’re not yet 55, a 10% early withdrawal penalty–on the initial value of those shares. But if the stock has gained enough, the cost can be worth paying.
Minneapolis financial planner Benjamin Wheeler recently helped a 44-year-old woman laid off from General Mills pull out stock worth $100,000, with an initial value of just $12,000, from her 401(k) plan. At the same time she rolled over $570,000 to an IRA, including $40,000 of higher-cost-basis company stock. “The 10% penalty was a drop in the bucket compared to the savings on the NUA,” Wheeler says.
What if your current employer is dropping the company stock option? If you’re older than 59 ½, you may be in luck, says Diane Morgenthaler, an employee benefits lawyer with McDermott Will & Emery. While they may not advertise it, 92% of large employers (according to an Aon Hewitt survey) allow older workers to take “in-service nonhardship” lump-sum distributions–you move your employer stock to a brokerage account and the rest of your 401(k) holdings to an IRA. Don’t worry–after the move you can still make new contributions to your 401(k) and get employer-match dollars.
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