There is a little-known strategy you can use if you have highly appreciated employer stock in your ex-employer’s retirement account and you are planning on rolling the account tax free to an IRA. Rolling the appreciated employer stock might not be the best choice.
There is a tax concept called Net Unrealized Appreciation that might be a smart financial move for you.
Rolling company stock to your retirement account directly to a traditional IRA is a tax-free transaction. However, when start taking money from your retirement account it is taxed as ordinary income.
What to Consider
At the time you roll your ex-employer’s retirement account take the employer stock “in kind” and roll the rest of the plan money into your IRA.
Taking the stock makes the cost basis in the stock is fully taxable to you as ordinary income and, if you are under 59 ½, it is subject to the early withdrawal penalties. The benefit is the stock appreciation is not taxed at the time of withdrawal. It is taxed at the lower long-term capital gain rates when you sell. Any further stock appreciation is also taxed at capital gains rates and not ordinary income tax rates.
What if You Hold the Stock?
If you are holding the stock at the time of your death, the heirs will get a “step-up” in basis and the cumulative stock appreciation (up to your time of death) will escape all income taxes.
Example: You are 60 years old. The value of ABC employer stock in your 401k is $200,000. The cost basis is $20,000. You roll the 401k to your IRA but in the process have the employer ABC stock distributed to you “in-kind” (which you move to your taxable brokerage account). You will be taxed on the $20,000 cost basis at ordinary tax rates. When you eventually sell the ABC stock, this gain of $180,000 (plus additional appreciation if stock is worth > $200K) will be taxed at the favorable lower capital gain rates.
If you hold employer stock in your company plan and this is something that might benefit you, please contact your tax advisor at Wegner CPAs to help you think through a retirement strategy.