One of the greatest opportunities in tax planning for retirement accounts is also one of the most overlooked and least understood strategies. For the right account, the tax savings can be enormous.
If you have your employer’s stock at a low basis inside your retirement plan, there is a little known provision that may be very valuable. You may withdraw your employer stock from the plan paying tax only on your basis.
This provision may allow you to transfer a significant value out of your plan at very favorable tax rates. The lower your average cost basis, the more dramatic the tax savings.
For example, suppose you have $1 million in company stock inside your retirement account, but the basis of the stock is only $100,000. You can take it all out and pay taxes on only $100,000! So, $900,000 was liberated at no tax cost. You pick the date when you pay taxes on that portion. Whenever you sell the stock the profit is subject to the very favorable 20% capital gains rates.
Even if the distribution is subject to a 10% penalty tax, it is only based on the basis of the stock. If the basis is very low, the penalty tax may be a trivial consideration.
If the stock pays dividends, then they are subject to the maximum 20% favorable tax treatment, which is far better than if they had accumulated inside and IRA and then distributed at ordinary income tax rates.
Another important benefit of the NUA strategy is that for any shares not liquidated after distribution, a step up in basis is available at death. So, the total appreciation will escape capital gains tax. This advantage is not available to an IRA, and may be a substantial estate planning benefit.
Keep in mind that this special provision for company stock must be part of a total distribution from the plan and must be accomplished in one calendar year. You may not pick and choose shares with different cost basis. Any shares distributed are valued at the average cost basis of the stock. The balance of the distribution may be rolled over into an IRA just like any other total distribution. However, if you roll over the stock into an IRA, the option is lost forever.
Note: It’s important to consider that the distributed shares may represent a substantial concentrated stock position with all the risks associated with any concentrated position. Normal risk management techniques are essential to prevent potential catastrophic loss due to the undiversified nature of the position.
As always, consult with a professional tax advisor to avoid any unpleasant surprises. But, don’t overlook this strategy if it applies to you.