Money Matters

Consider special tax rule before rolling company stock to an IRA

March 2, 2013 

Q. I am taking a severance package this year after 25 plus years with the same company. My 401k plan is heavily invested in company stock. Several years ago I remember reading (it very well may have been one of your columns) about taking company stock and leaving it outside of an IRA when retiring. Could you please explain this strategy and how it may be more beneficial than rolling the whole account to an IRA?

A. There is a special tax rule for company stock in a retirement plan and it could save you thousands of dollars in taxes. This potential savings is lost if you roll the company stock to an IRA. With company stock, if you keep it outside an IRA, you’ll owe income taxes only on the value of the shares at the time they were purchased in your retirement account, this is known as the cost basis. When you sell the stock you will pay the lower long-term capital-gains tax (0 - 20 percent depending on your tax bracket), not income tax (10 - 39.6 percent). Anyone with a large amount of highly appreciated stock in their retirement account could benefit from this tax rule. Other factors to consider before you or other readers choose this strategy are: your age, how much has the stock appreciated, future growth potential of the stock, impact of the lack of diversity on your portfolio, availability of funds to pay the upfront taxes on the cost basis, how long you plan to hold the stock, whether you plan to leave it to heirs and your tax bracket in retirement.

Example: Cost basis of company stock is $20,000 and the fair market value is $100,000. By requesting that the company stock be distributed to a taxable account, you will pay ordinary income tax on the cost basis, $20,000. The remaining $80,000 which is the difference between the cost basis and the market value of the stock ($100,000 - $20,000) is called “net unrealized appreciation.” That amount can continue to grow tax deferred as your company stock appreciates. When you sell shares of stock in retirement to meet expenses you will pay long term capital gains tax, which is lower than regular income tax. If the stock were in an IRA, all the money would be subject to the higher income tax when withdrawn.

Monies in non-company stock should be rolled directly to an IRA.

Each person’s situation is different, if you are facing major financial decisions find someone with the expertise you require and be willing to spend some money for objective advice.

Holly Nicholson is a certified financial planner in Raleigh. She cannot answer every question. Reach her at askholly.com or P.O. Box 97128, Raleigh, NC 27624

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