When a participant needs to decide between a distribution of company stock or taking its cash value from a 401(k) plan, a choice must be made: roll it into an IRA, or distribute the company stock into a taxable account and roll the remaining assets into an IRA.
Participants who elect a lump-sum distribution of the company stock to a taxable account pay only ordinary income tax on the stock’s cost basis: that is, the price paid for the stock. If the participant is younger than age 59½, he or she also may be subject to an additional 10% federal tax.
When shares of the stock are eventually sold, the participant will pay long-term capital gains (LTCG) tax on the stock’s NUA: that is, the difference between the price initially paid for the stock (cost basis) and its current market value. Any post-distribution growth also will be taxed then, as either short-term capital gains (STCG) or long-term capital gains, depending on the holding period after the distribution.
A participant must meet all the following conditions to qualify for NUA:
1. Experience a triggering event:
2. Distribute the company stock from the 401(k) or qualified plan in-kind to a taxable account.
3. Distribute all remaining assets from the 401(k) or qualified plan with that employer within one tax year.
The NUA strategy primarily benefits individuals who own appreciated employer stock in a 401(k) or other employer-sponsored retirement plan. The higher the income-tax bracket and the more the stock has appreciated, the more a participant may benefit from this strategy.
The NUA will be taxed at favorable long-term capital gains rates when the stock is sold. Any post-distribution growth also will be taxed then, as either short-term or long-term capital gains, depending on the holding period after the distribution.
In the following example, the $5,000 of appreciation accrued after the lump-sum distribution will be taxed as either short-term or long-term capital gains, depending on the holding period.
For more information on NUA rules as well as situations that trigger additional tax restrictions, review IRS Publication 575, Pension and Annuity Income.
As always, participants should seek guidance and consult their personal tax advisors to help determine whether the NUA strategy is an appropriate course of action based on their specific situations.
For more information on retirement-planning strategies, please contact the Retirement Strategies Group at (800) 722-2333, or email us at RSG@PacificLife.com.
Pacific Life, its distributors, and respective representatives do not provide tax, accounting, or legal advice. Any taxpayer should seek advice based on the taxpayer's particular circumstances from an independent tax advisor or attorney.
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Variable insurance products are distributed by Pacific Select Distributors, LLC (member FINRA & SIPC), a subsidiary of Pacific Life Insurance Company (Newport Beach, CA) and an affiliate of Pacific Life & Annuity Company. Variable and fixed annuity products are available through licensed third parties.
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