How to Get Company Stock Out of Your 401(k) and Pay the Least Amount of Tax
Many workers own stock in their employer’s publicly-traded company. Frequently this stock is held in a retirement plan, such as a 401(k), and rolled into an IRA when people retire because they think that this is their only option. The IRS, however, gives you another choice that could save you thousands of dollars. The amount of 401k tax you ultimately pay will depend on the choices you make.
When you eventually take money from an IRA, whether to meet your expenses or Required Minimum Distributions (RMD), it will be taxed as ordinary income. And you’ll have to pay the same tax rate on company stock that you had rolled over to the account. But there is a way to avoid the tax on the stock’s Net Unrealized Appreciation (NUA).
The NUA is the difference in the stock’s value from the time it was purchased to the time you withdrew it from the retirement plan. If you remove the stock after you leave your firm, you will only have pay ordinary income tax on the cost of the stock when it was acquired by the plan. As soon as you transfer your stock to a regular brokerage account you would also rollover the balance of your 401k distribution to an IRA. That way those funds will continue to grow tax-deferred, eliminating any 401k tax for the time being.
If you get rid of the stock, you will only pay the lower, long-term capital gains rate on the NUA. And since the standard one-year holding period does not apply to NUA, you could sell the stock the day after you transfer it out of your 401(k) and pay the lesser tax. However, to receive the capital gains rate on future appreciation, you must own the stock for more than one year. If not, you will have to pay the ordinary income tax rate.
Using the NUA tax break gives you another great money-saving 401k tax benefit: There will not be any pesky RMD on the stock because it is not part of your IRA. Hence, the IRS cannot force you to sell and pay taxes on it after you turn 70½.
Your loved ones will thank you, too.
When beneficiaries receive IRAs, they must pay ordinary income taxes on all of those funds. Inherited NUA stock, however, gets a better deal. Heirs can take advantage of the same favorable treatment as you. They will receive the stock at your cost basis and pay tax on the NUA at the capital gains rate. But they get a special break if you had used the NUA rule: Appreciation from the date you removed the stock from the plan to the date you died will receive a step-up in basis and pass income-tax free.
IRS Reg. 1.402(a)-1(b), (e)(4)(B), (e)(4)(D) , http://www4.law.cornell.edu/uscode/search/display.html?terms=net unrealized appreciation&url=/uscode/html/uscode26/usc_sec_26_00000402----000-.html
IRS Notice 98-24, http://www.irs.gov/pub/irs-drop/not98-24.pdf
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Company 401K rolled to annuity 2 years ago. Monthly dispersements taken, income taxes paid monthly. Is this counted as income in retirement toward Social Security?
If you are talking about income that offsets social security income, the answer is NO, the annuity income is not included because the limitation on income before you start losing social security benefits is on EARNED INCOME (i.e income from a job or self employment) and only impacts people who have not reached their full retirement age (age 66 for most).
However, if you are talking about income that makes your social security benefits subject to income tax then YES, the annuity income is part of the includable income which figures into your total income when the IRS figures whether to tax your social security benefits and how much to tax.