If your 401k plan includes some of your employer’s stock, you need to understand there are two ways to move employer stock out of a 401k. While some are better than others, at REAP Financial, we want to help you reduce the tax on your distributions as much as possible. In this article, we’ll go over the best strategy to handle company stock in a 401k plan to minimize taxes.
The NUA Strategy
If you have company stock in your 401k plan, there is a little-known strategy you should be leveraging to minimize taxes paid on that stock. When most people retire, they roll their entire 401k to an IRA through an IRA rollover. This makes a lot of sense for retirees who don’t have company stock in their 401k plan. However, if you do have company stock in your 401k when you do a complete IRA rollover, you’ll be locked into paying income tax rates on that stock when you want to take it out in retirement.
To combat this, you can use the NUA strategy. This stands for Net Unrealized Appreciation. With this strategy, you move all of the non-company stock portion of your 401k into an IRA through a tax-free rollover. Then, you take the company stock and distribute it to a taxable brokerage account. When you do this distribution, it must be distributed in kind, directly to the taxable brokerage account. If you do not distribute it in kind, by rolling it into an IRA before moving it to a brokerage account, you’ll lose the potential tax advantage.
Benefits of the NUA Strategy
When you distribute the company stock into a taxable brokerage account, it becomes taxable at capital gains rate. Since the capital gains rate is normally 15%, this puts you in a much more favorable position, as compared to the income tax rate you pay while you’re working (likely 22%, 24% or 32%). By doing this, you can transfer the company stock out and pay capital gains tax on whatever growth the stock has experienced since you got it. By following this NUA strategy, you pay far less in taxes. Then, growth on the stock in the future can be sold at favorable, capital gains rates as well.
Another thing to consider is when you take money out of your 401k. In most cases, if you take money out of your IRA or 401k before age 59.5, you’d have to pay tax and a 10% penalty in most cases. However, by using the NUA rule, you can get more liquidity out of your 401k or IRA plan before age 59.5. When you distribute the employer stock, you are subject to the capital gains tax, but not to the 10% penalty. This gives you access to more of your retirement dollars before age 59.5, without subjecting you to that extra penalty.
Getting the Most Out of Your Retirement Funds
When it comes to company stock and the NUA strategy, it can be quite complicated. You’ll want all the right information on hand to set it up correctly. For more information on the NUA strategy and other must-know strategies, get your free copy of our guide, 10 Retirement Tips: Essentials for Harvesting a Fulfilling Financial Future. Simply send an email requesting the report to retire@reapfinancial.com, and our REAP Financial team will send it directly to your inbox.
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