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Minimizing Taxes On Employer Stock In Your 401(k) Plan – Tax – United States

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Minimizing Taxes On Employer Stock In Your 401(k) Plan

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If you are approaching retirement and your 401(k) plan contains
significant holdings in appreciated employer stock, you may be able
to minimize your tax liability related to that stock. This
strategy, which takes advantage of the net unrealized appreciation
(NUA) rules, is not right for everyone, but it is worth exploring
before you start withdrawing funds from your 401(k) plan or rolling
them over into an IRA.

Related Read: Approaching Retirement? How to Deal With Market
Volatility

Three Steps to Take Advantage of the net unrealized
appreciation (NUA) Rules

NUA is the excess of the market value of employer securities at
the time of distribution over the cost or other basis of such
securities.

Generally, distributions from 401(k) plans or traditional IRAs
are taxable as ordinary income. But under the NUA rules, you can
elect to defer paying tax on the appreciation in value of employer
stock until the shares are liquidated. At that time, appreciation
may be taxable at favorable long-term capital gain rates.

Related Read: Three Tips for Making Retirement Less
Taxing

The rules are complicated, but in general, you would:

  1. Take a lump-sum distribution of your entire 401(k) account at a
    time when you are eligible due to separation from your employer,
    disability or reaching age 59½. You must receive actual
    shares of employer stock rather than their cash value.
  2. Move some or all of those shares to a taxable brokerage
    account, paying ordinary income tax on the stock’s cost basis
    when the stock is distributed to you. Tax on the shares’ net
    unrealized appreciation is deferred until you sell them.
  3. Rollover any other 401(k) assets into an IRA.

If executed carefully, this process can reduce taxes on the sale
of employer stock. But for that to work best, the stock should be
distributed at a time when you have little or no taxable income –
for example, when you have first retired but have not yet begun to
receive Social Security benefits, pensions and other income.
Ideally, you would want to time the liquidation of your employer
stock shares so that it makes the most of the lowest capital gains
tax rate.

But before executing this strategy, consider the broader impact
of moving funds into a taxable account – and the possible
alternatives. For example, you might benefit from options such as
leaving the funds in your existing plan or transferring them into a
new employer’s plan. Other considerations are fees, expenses,
investment options and creditor protections.

Holding a substantial amount of wealth in one company’s
stock is also risky. Your ORBA tax or legal advisor can help you
determine whether this strategy makes sense given your
situation.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.

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