Convert 401k to IRA but Not Employer Stock

You are getting close to your retirement or have already arrived. What happens with all those contributions you and your employer have made to your 401(k) plan? Do you convert that 401k to IRA?

It is wise to convert a 401(k) to IRA for number of reasons which include reducing investment fees, reducing administrative fees, increasing investment options, easier monitoring and re-balancing of your account, etc. However, should you convert 401(k) to IRA assets, there is one asset that you rarely want converted. That asset is employer stock you may own in your 401(k) account.

There is a tax advantage given to employer stock in a 401(k) that if improperly removed, the advantage is lost. The advantage works as follows. If you do not rollover the stock into an IRA but rather distribute the stock to yourself, you will pay income tax on the basis of the shares today. The basis is the amount originally paid for the stock which may have been purchased many years ago is hopefully very low. Let’s say that amount is $50,000. You would pay tax on $50,000 today when you distribute the shares. But let’s say the stock is worth $500,000 because of appreciation. Here’s the good part. If you distribute the stock and do not roll it over into the IRA, when you later sell the stock, that appreciation is taxed at capital gains rates. Had you rolled the stock into an IRA, that appreciation would have ended up being taxed at ordinary rates. In this simple example, the wrong move would’ve cost you $90,000.

Using this special tax advantage, that IRS calls the net unrealized appreciation rules, is not always advantageous. It is advantageous in this circumstance where the appreciation on the purchase stock has been significant and paying taxes on the basis today is not too painful or onerous. In cases where the appreciation is not significant, all assets can be rolled over into an IRA.

If you do treat the stock as explained in this article, then certainly for the remaining assets, convert 401k to IRA assets for continued tax-deferred growth.