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Money Matters: Special tax rule for company stock can save you thousands in taxes

Q. I’m retiring from my company after a 35-year career. I hold a lot of company stock in my company profit sharing and 401(k) plan. I’ve interviewed several investment professionals to help me manage/invest this money once I retire. All of the advisers except one suggest I roll my stock to an IRA, sell it and invest in a variety of mutual funds, stocks and/or bonds with their firm. The one adviser wants me to consider another option which involves taking my company stock and leave it outside of an IRA when I retire. She said there are initial tax implications but since the company stock is a highly rated blue chip and my cost basis is so low, the advantages of her plan outweigh the initial tax hit. She is of such a strong opinion that this is the best strategy she said she won’t work with me unless I sign something stating that this was discussed and I chose not to follow her advice. I kind of admire her taking a strong stance on this, but I’ve never heard of this strategy and neither have the other advisers I’m interviewing. They agree with me that it seems silly to pay taxes on a lump sum instead of paying taxes as I take distributions in retirement. Are you familiar with the option of taking my stock when I retire, not putting it in an IRA and the benefits, if any, of doing so?

A. So, even after you mentioned this strategy to the other advisers, they didn’t bother to research it and determine if it would make sense in your situation? I’d select the knowledgeable adviser with whom to work whether or not you decide to use the strategy she has suggested. The strategy is called Net Unrealized Appreciation or NUA.

This 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 outside of an IRA, you will pay the lower long-term capital-gains tax (zero to 20 percent plus an additional 3.8 percent net investment income tax for those in the top bracket), not ordinary income tax (10 to 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 this strategy is chosen are: your age, how much the has 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 of the NUA strategy: Assume an average cost basis of $20/share on 5,000 shares of company stock with a current value of $70/share held in your company retirement plans. If you take the company stock when you retire, you will owe regular income taxes on the cost basis of your distribution (5,000 times $20 = $100,000). The remaining $250,000, which is the difference between the cost basis and the market value of the stock ($350,000 minus $100,000) is called “net unrealized appreciation” (NUA). The NUA amount can increase if 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 rolled into an IRA, all the money would be subject to the higher income tax when withdrawn.

NUA can be a great strategy, but it’s not for everyone. Once the highly appreciated stock is rolled to an IRA, the ability to use the NUA strategy is lost. I don’t blame the adviser for wanting it in writing that this strategy was presented and declined. The involvement of a tax professional or another knowledgeable adviser that you are not considering helping you manage this money may be helpful in making this decision.