Net Unrealized Appreciation and 401k Rollovers

Special Tax Provisions for Company Stock and 401k Rollovers

If your company 401k plan includes highly appreciated company stock, have your plan administrator withdraw the stock and roll the balance of the plan assets to an IRA. This way you pay no current tax on the Net Unrealized Appreciation (NUA - the amount that the stock has appreciated since you purchased the shares). Additionally, you won't pay current tax on the other assets rolled over to the IRA. The only current tax would be on the cost of the stock when acquired by the plan. This is a special consideration when contemplating 401k rollovers.

If you withdraw the stock and are under 55 years old, assuming you no longer work at the employer, you'll have to pay a 10% penalty. But the penalty is only applied to the amount that is taxable.

You can then defer the tax on the NUA until you sell the stock ( we provide an illustration below). When you do sell, you only pay tax at the then-current capital gains rate. To qualify for the tax deferral on NUA, the distribution must be a lump-sum distribution meaning that all of the employer's stock in your plan account must be distributed. Since this is almost always done in conjunction with 401k rollovers, the other assets get rolled over to a traditional or Roth IRA.

Case Study

Jackie is just retired and has company stock in her profit sharing plan. The cost of the stock was $200,000. But it is worth $1 million now. If she were to perform a 401k rollover of the $1 million to her IRA, the money would grow tax-deferred until she took distributions. At that time, the withdrawals would be taxed as ordinary income. When Jackie dies, her beneficiaries will pay ordinary income tax on all of the money they receive.

But if Jackie withdrew the stock from the plan rather than rolling it into her IRA, her tax situation would be different. She would have to pay ordinary income tax on the $200,000. However, the $800,000 would not be taxable. And she will not have to worry about required minimum distributions. If she eventually sells the stock, she will pay the lower capital gains tax on the net unrealized appreciation and any additional appreciation .

Jackie's IRA beneficiaries will not receive a step-up-in-basis for the NUA. However, they will only pay at the capital gains rate. And appreciation between the distribution date and the date of death will receive a step-up-in-basis; therefore will pass income tax free.

With NUA		Without NUA
35% Tax on $200,000	$70,000	35% Tax on $1 million	$350,000
15% Tax on $800,000	$120,000

Total Tax	$190,000		$350,000

Let's assume the value increased to $1.5 million in five years, and she decided to sell.

	With NUA	Without NUA
Taxable Amount	$1.3 million	$1.5 million
Tax Rate	15%	35%
Potential Income Tax to Jackie	$195,000
Plus Amount Previously Paid	$70,000
Total Tax	$265,000	$525,000