Company stock in your 401(k)? It's unwise to roll it over to IRA

[question everything]

Company stock in your 401(k)? It's unwise to roll it over to IRA

By Lynn O'Shaughnessy
May 21, 2006

If you have company stock sitting in your 401(k) account, you'll have to tackle more complicated choices when leaving your job than the folks who are only ushering plain old vanilla mutual funds out of the building.

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Here's an example of how NUA (net unrealized appreciation) works: Suppose you have $150,000 worth of company stock in a 401(k) that you acquired over the years for just $25,000. The profit, or NUA, is $125,000, but if you move the shares to a taxable account, you'll only owe immediate taxes on the $25,000 cost basis. If you're in the 25 percent tax bracket, for example, your tax bill would be $6,250. A 401(k) investor who is under the age of 55 would also have to pay a 10 percent early withdrawal penalty. The penalty, however, is assessed on what you paid for the stock and not its current value.

If you ever unload your company stake, you'd also face long-term capital gains taxes on the profit. If you hold onto your shares in the taxable account for more than one year, the maximum rate tops out at 15 percent. And that's one of the true beauties of the NUA tax break. But to appreciate why this can be such a great maneuver for stock that's increased in value, you have to understand what would happen to your equity mother lode if you transferred it into an IRA.

It is true that you'd owe no taxes as long as the stock remained undisturbed inside the IRA. But it's when you sell the stock and begin pulling out the cash that the IRS will grab its cudgel and start swinging. If you cashed out your stock position and withdrew the money, you'd owe income tax on the whole amount. Income tax rates, by the way, reach as high as 35 percent, and it's highly likely that selling a big block of stock would bump up your tax bracket. In this particular scenario, someone in the 25 percent tax bracket would pay $37,500 in taxes. Now let's contrast this tax bill with the one that our guy who moved his stock into a taxable account ultimately paid. In addition to the $6,250 he'd owe in taxes initially, he'd pay an additional $18,750 if he ultimately sold the stock at the more desirable long-term capital gains rate. His total tax tab would be $25,000. That's a $12,500 difference.

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Here's another rule you must follow: To qualify for the favored tax treatment, you have to empty your 401(k) in one tax year. Let's say you leave your job in September and you transfer the company stock into a taxable brokerage account, but you wait until June to move the rest of the 401(k) into an IRA. That delay will scotch the NUA tax break. Even many people who are aware of the NUA benefit probably don't realize it can outlive them. If you inherit a stockpile of company stock in a 401(k) plan, you can capture the NUA tax break by moving the stock portion of the 401(k) into your own taxable account.

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Find this article at:
http://www.signonsandiego.com/uniontrib/20060521/news_lz1b21company.html

[buczak]

1. asking for trouble.

Anyone who has primarily one stock in their 401k is asking for trouble anyways. You have to diversify, people. :)

[mcscajun]

2. Damned straight! Your work is your investment in the company

that employs you.

Nothing wrong with owning a little, but more than that is just plain crazy. If your company goes south, you lose everything, your job and your nest egg.

[question everything]

3. Enron! Enron! Enron!

as a great example of what happens when people load their retirement funds with shares of their employer.

[Yupster]

4. Agree QuestionEv

Having your paycheck dependant on a company is risk enough.

Loading up your 401(k) with company shares too is just plain greedy, and/or foolish.