Do you hold any (highly appreciated) company stock in your 401K?

[Coytee]

I had a conversation the other day with a gal who held some highly appreciated stock in her 401K. Her cost basis was something like $20,000 and the value of the stock was around $160,000. IRA account value was around $300,000

As a matter of regular process, I explained "NUA" or Net Unrealized Appreciation to her. Since she was looking at taking about $200K out of her 401K, I suppose I was even more intense in my determination that she understand the process. Her parting comment to me was, she was going to talk to her friend who owns his own business about NUA. After I asked if he was a CPA, I found out he owned an insurance company.

So be it. We're getting together this week so we can go to step 2. I hope he knows how to use google and get her the answer, else she'll be paying a ton more in taxes than she needs to.

So, with that, I thought I'd bring this subject up here since there are probably eyeballs that read this forum who might or might not be active, and have some highly appreciated company stock in the 401K plan.

Generally, I don't make too much of the conversation if the amount of gain is less than 200% ($10,000 cost basis now worth $30,000) or, if the market value of the stock is under $10,000. I'll mention it but, won't go into great detail. Funny thing is, in my desire to educate & help this gal, I suspect that I scared her away about it, making her think it was some form of a gimmick. It's not something most people have heard about.

So, I just now did a simple google on it and copied one result below. The below article says it's not always prudent to be deep into the company stock. I can agree with that. He also says by doing the NUA, you give up some benefits on your death for your beneficiaries by passing it onto your heirs.

I actually disagree a bit with that assessment and here's why.

Under the presumption that you can pull the stock out of the IRA at say, $20,000 cost basis and it's current market value is now $160,000 as per this lady, if you can finish your life without selling the shares at all, your beneficiaries can inherit the shares and get the stepped up cost basis at your time of death.

So, I now ask you... if this is yourself what would you want to leave to your children or, if this is your parent, how would you want it left to you?

IRA: As beneficiary, you (the beneficiary) can take the value of the IRA and 'stretch' it over your lifetime, keeping the balance of the account tax deferred for the rest of your life. You must take out a minimum distribution each year based on your attained age. Any funds you take out of the IRA will be reported as taxable to you for that year however, you will never be faced with the 10% premature distribution (even if you are age 10) because it's coded as a death distribution.

NUA: As beneficiary, you inherit the shares at the stepped up cost basis as of date of death. Now, if you sell the shares immediately, you have no real tax consequence because the stock is currently at or near the value of date of death. Or, if you hang on to the shares for 20 years and the shares go up 50% or some number.... you pay capital gains on them, not income tax as you do if the shares stay in the IRA. If the stock falls in price (relative to date of death) you would then have a capital loss situation which can currently be deducted from your taxes.

Though someone might like the idea of a fatter inherited IRA account to help fund them through their life, I tend to fall favorably into the camp of taking the (tax free) jump up in cost basis. I don't think either answer is necessarily wrong given the proper circumstances. I'm simply admitting my bias.

http://money.cnn.com/2005/12/22/pf/expert/ask_expert/

Company stock: The secret tax benefit Taking advantage of this strategy when you retire can save you big bucks come tax time. December 23, 2005: 9:46 AM EST By Walter Updegrave, CNNMoney.com contributing columnist

NEW YORK (CNNMoney.com) - I've heard that if you own company stock in your 401(k) plan that you can take an "in-kind" distribution when you leave your employer, and as a result, you would pay ordinary income tax on what you paid for the stock, but long-term capital gains rates on any appreciation. Sounds like a good deal. Is it true? -- V. Dalconzo, Washington, Utah Yes, it's true all right. This little-known tax benefit is known as NUA, or net unrealized appreciation, and it has the potential for saving you mucho bucks on your tax bill. Here's a little example. Let's say that you're ready to retire and you have $500,000 in your 401(k) account, $400,000 of which is in assorted mutual funds and $100,000 in your employer's stock. And let's further assume that the original cost of your company stock -- that is, the amount you and/or your employer contributed to your account over the years to acquire it -- was $20,000 and the remaining $80,000 was appreciation. That $80,000 represents your NUA, or net unrealized appreciation, in employer stock. If you decide to simply move your entire 401(k) account to an IRA rollover, your $500,000 would continue to grow without the drag of taxes until you pull your money out, but all withdrawals you make from your account would be taxed at ordinary income rates, which could go as high as 35 percent. But you have another choice -- take advantage of the NUA strategy. To do that you would transfer only the mutual fund portion of your 401(k) to an IRA rollover and take an in-kind distribution of your company stock -- that is, you would get your 401(k) plan give you the actual shares. In that case, you would pay tax at ordinary income rates on the original $20,000 cost of your company shares. You would also have to pay tax on the NUA, or $80,000 of net unrealized appreciation. But that amount would be taxed at long-term capital gains rates that max out at 15 percent. In other words, instead of owing as much as 35 percent, or $35,000, on the total $100,000 of your company stock, the most you would be on the hook for is 35 percent, or $7,000, on the $20,000 original cost plus 15 percent, or $12,000 on the $80,000 of NUA, for a total tax tab of $19,000. That translates to savings of $16,000 ($35,000 vs. 19,000) in this example. The numbers would be different, of course, if you're in a lower tax bracket. But as long as ordinary income rates are higher than long-term capital gains rates (which they are), you would still benefit. (By the way, you can also do this if you're leaving your company but don't intend to retire. Although if you're under age 55, you'll owe an additional 10 percent tax penalty.) What if you decided to hold your company stock instead of selling immediately? Well, you would still owe tax at ordinary income rates on the $20,000 original cost of the shares, plus tax at long-term capital gains rates on the $80,000 of NUA. But you wouldn't be taxed on any additional appreciation in the value of the shares after were removed from your 401(k) until you sold them. So, for example, if the value of your company shares rose from $100,000 the day they were transferred from your account to $120,000 and you sold within a year, you would be taxed at ordinary income tax rates. If you waited longer than a year, however, the $20,000 of additional appreciation would be taxed at the lower long-term capital gains rate. Pros and cons of NUA All in all this is a pretty sweet deal, although the there are some things you should think about before going the NUA route. One is that by holding a large amount of your wealth in the shares of one company (whether in your 401(k) or afterwards), you're taking on more risk. If your company's fortunes sour and the value of those shares head south in a hurry -- Enron being the worst-case scenario -- you could be in big trouble. So I don't recommend bulking up on company stock in your 401(k) just to cash in on this tax benefit. And don't assume that it's a given that NUA is the best way to go. For some scenarios, such as passing money along to heirs, an IRA rollover can have advantages too. So before you decide to take the stock, you may want to have an adviser crunch the numbers on various options. You may also want to do some more research on this issue on your own, a process you can start by clicking here and here. One final tip: once you do a rollover, there's no going back. You can't undo it and take the stock instead. So if you own a decent amount of highly appreciated company stock in your 401(k), check out the pros and cons of NUA before you start moving your 401(k) money around. Otherwise, you could end up enriching Uncle Sam's coffers at the expense of your own.

[Coytee]

I might add there are some conditions to do NUA. Let me preface with I'm not a CPA, I always urge someone to speak with their CPA.

1. To do NUA, you must do it at the time of taking the shares out of the 401. They are rolled directly into the NON-IRA account. In other words, you can't roll them to your IRA and decde to do it later. Once you roll them to your IRA the party is over and you're screwed.

2. You must deplete your 401K. In other words, you can't take just your shares out of the account, leaving your mutual funds in. This isn't a big deal since you should (if able) roll your 401 balance into an IRA anyway. As I understand it, the 401 is required to be taken to a zero balance for this to work.

3. If you are 59 1/2 or older, still working, you can roll your entire 401K out (taking it to a zero balance) and peel the company shares off to a taxable account, thereby doing the NUA while you are still employed there and making current contributions. In other words, you are not required to terminate any employment however, if you are 50 years old or some age below 59 1/2, you might be handcuffed until you do seperate from employment.

This has been a public service announcement, you may now return to your regularly scheduled Klipsch sessions

[Y]

[T2K]

An old man told me once If you're gonna play the game, boy, ya gotta learn to play it right. You got to know when to hold 'em, know when to fold 'em, know when to walk away and know when to run. You never count your money when you're sittin' at the table. There'll be time enough for countin' when the dealin's done.

Your thoughts?

Keith

[Mongo171]

Was that old man a CPA?

[T2K]

Was that old man a CPA?

Yes, he was a Country Performing Artist.

Awfully generous of you to take your time to type all of that valuable info coytee.

Since I'm an older codger I now understand the value of time. Since I'm about to quit working for a living I have been trying passionately to express to trainees the importance of taking the free money that our employer offers in the company investment plan. I'm somewhat dumbfounded by the general lack of feedback that most all of these new hires give. Some of them seem as dumb as I was years ago, and that's hard to believe.

The company match is not that much but if you contribute the minimal amount necessary to receive the yearly maximum company contribution then it adds up over time. Roughly the minimum yearly employee contribution to max out the company match would be around $1800. The miniscule yearly company match given the aforementioned contribution would be around $600. It's not much but it's free money.

After explaining the Rule of 72 and running the numbers on a piece of paper it is easy to see that over time a small amount of money compounds unbelievably over several decades. If you run those numbers over 40 to 60 years then it is easy to see that the seemingly small amount of money becomes a large amount of money over time. The impressive figures that do garner attention are those that come after compounding an amount of money 6 or 8 times over. But those figures require time. The one thing that you cannot buy is time. You cannot buy time. So starting early is extremely important.

Of course, you understand all of this. Your post offered valuable information that is useful in holding on to a persons hard saved dollars. I hope that you will continue to offer free knowledge here because of it's importance. I think it's important because I was once young and dumb. Now I'm old and dumb. But then, there's the annuity.

Thanks for posting.

Keith

[skonopa]

Since I'm an older codger I now understand the value of time. Since I'm about to quit working for a living I have been trying passionately to express to trainees the importance of taking the free money that our employer offers in the company investment plan. I'm somewhat dumbfounded by the general lack of feedback that most all of these new hires give. Some of them seem as dumb as I was years ago, and that's hard to believe.

The company match is not that much but if you contribute the minimal amount necessary to receive the yearly maximum company contribution then it adds up over time. Roughly the minimum yearly employee contribution to max out the company match would be around $1800. The miniscule yearly company match given the aforementioned contribution would be around $600. It's not much but it's free money.

Exactly! I thank God everytime that I jumped on the 401(k) and contributed at least enough to get the "free" company matching the moment I was elgible (I had to work at least a year at that job before being eligible).

I looked into that NUA stuff, but since when I left that company (after 14 1/2 years), I was still only in my mid 30's, so I would've gotten beat-up on the 10% early distribution penalty. Since what that company was in thier stock, there is a lot of that company stock in that 401(k). So, I basically said "f-it!" and pretty much rolled the thing into an IRA. My current company does not have stock (it is a tiny, privatly-owned, firm, well, no so tiny now - when I started, it was only 9 of us, now we got some 50 or so employees - I am the most senior engineer on our flagship product). However, in order for my current company to match, an employee would have to contribute at least 4% before the company would would match its 4%. I have mine nearly maxed out, as well as my IRA maxed out. Sucks that I make too much money to take any tax benefits on the IRA contributions, though. [:S] Believe me, I tried (ANYTHING to reduce my tax load - hell, I even took on an HSA for my healthcare, and maxed that out as wel!!).

[Coytee]

ANYTHING to reduce my tax load

Losses are always fun to use to save some taxes... [6]

[oldtimer]

ANYTHING to reduce my tax load

Losses are always fun to use to save some taxes...

If you have unavoidable losses I could see the fun. The crux is Unavoidable. Otherwise I laugh out loud at those who would praise losses for tax reduction. It's like those who talk down owning outright your own home, because you lose the mortgage tax deduction. As long as rates are below 50% you lose with the mortgage. It becomes a matter of who would you rather pay, the government or the bank. And the bank takes more of your money. You can show the math to some, and they still can't get it. It's not how much money you make, it's how much you keep.

[skonopa]

It's like those who talk down owning outright your own home, because you lose the mortgage tax deduction. As long as rates are below 50% you lose with the mortgage. It becomes a matter of who would you rather pay, the government or the bank. And the bank takes more of your money. You can show the math to some, and they still can't get it. It's not how much money you make, it's how much you keep.

That's the kicker here for me. In fact, my house is nearly paid for. Yeah, getting the tax deduction is nice, but in the end, I would rather be completely debt free, including the house mortgage. I would more than likely do better putting that money each month in an investiment account, even with the tax deduction, than having to send that money to Wells Fargo. []