Rolling Over Company Stock: Think Twice About from a 401(k) Plan (2024)

When employees leave a job that came with a company retirement plan, it's customary for them to roll over the balance in the plan's 401(k) into a traditional IRA. This allows the person to continue deferring taxes on the account's earnings until they retire and begin taking distributions.

Or it does, at least, for most of the plan's assets. But if your 401(k) includes publicly held stock in the company you're leaving, you shouldn't automatically roll these assets over to an IRA. It may make more sense to instead move the stock to a brokerage account and pay at least some tax on it immediately.

Here's a rundown of why that's the case, along with advice on how you should proceed in handling company stock when you depart a company. The explanation gets a little complex, but it's worth reading. Thousands of dollars in tax liability could be at stake.

Net Realized Appreciation (NUA) Explained

The underlying reason to pause before rolling over company stock can be summarized in three letters: net unrealized appreciation (NUA). The NUA is the difference between the value of the company stock at the time it was purchased or given to you and put into your 401(k) account, and what it's worth when it's transferred out of the 401(k).

How that appreciation in the stock's value is ultimately taxed depends on the account to which the stock is transferred from your 401(k). If the transfer is to an IRA, you don't pay any tax immediately, which is helpful. But you're liable to pay income tax on the stock's full NUA when you sell it.

Moving the stocks to a brokerage account, on the other hand, requires you to pay income tax immediately on the cost basis of the stock—what it was worth when you acquired it. But there's a long-term advantage. When you eventually sell the stock, the NUA will be taxed as a capital gain, at rates that are lower than most pay in income tax.

Using NUA Helps Avoid Required Minimum Distributions

Avoiding an IRA transfer for your stock also allows you to skip being forced to disburse some of their value under the IRS rules for retirement accounts.

Company stock held within an IRA becomes subject, like all retirement account assets, to required minimum distributions (RMDs). That is, once you turn 73, a certain amount of the value of the account must be taken out annually. You may have to sell some of the company stock if you can't or don't wish to tap other assets in the account to satisfy the RMD requirement.

However, when you take advantage of the NUA tax break for your company stock (by not rolling it over into an IRA), you're free to sell the stock whenever you wish, since it will be free of the distributions demanded by an IRA.

NUA: A Plus With Quick Stock Sales

It's also advantageous to hold company stock outside an IRA if you wish to sell your company stock immediately after you depart the organization.

In general, you're required to hold stocks for a year before selling them to be eligible for taxation at the capital gains rate rather than at the income tax rate. Not so with stock that's been transferred from your retirement plan to a brokerage account. You'll be free to sell the shares the day after you transfer them out of your 401(k), and pay only the current capital gains rate on the NUA, rather than the income tax rate you'd pay if they were held in an IRA.

One caveat, though: This break does not apply to any further appreciation in the stock after it is transferred out of your 401(k). Let's say you decide to wait to sell because you believe the stock will rise further in value. Any such increase between the transfer from your 401(k) and the sale is subject to the usual rules for capital gains.

That is, the gain will be subject to income tax unless you hold the securities for more than one year before selling.

Any dividends earned on the stock before you sell it are also taxable at your ordinary income tax rate.

The Tax Benefit to Your Heirs

These same benefits flow to your heirs if they inherit company stock that was transferred by you from a 401(k) to a brokerage account. The heir can sell the stock immediately and pay capital gains tax on the proceeds, not income tax.

Further, your heir gets favorable treatment when it comes to how that gain is calculated.

The heir does not pay capital gains tax on the full appreciation in the stock's value from its original cost basis. The tax will only be on the appreciation since the stock was inherited.

The net result is that your heirs skip paying tax on any increase in the value of the stock during the time that you owned it. That would not necessarily be the case if they inherited the stock in an IRA rather than in a brokerage account.

How NUA Can Save Taxes: A Case Study

Let's go through an example to demonstrate these tax treatments.

Mike is 57, about to retire, and has company stock in his 401(k) plan. The original value of the stock was $200,000, but it is now worth $1 million.

If he were to roll the $1 million over to his IRA, the money would grow tax-deferred until he took distributions. At that time, the distributions would be taxed as ordinary income.

If Mike doesn't sell the stock before he dies, the beneficiaries of his IRA will pay ordinary income tax on all of the money they receive, including the current value of the stock.

If, on the other hand, Mike withdraws the stock from the plan rather than rolling it into his IRA, his tax situation would be different, as would that of his heirs. He would have to pay ordinary income tax on the original cost of $200,000. However, the remaining $800,000 would not be subject to his ordinary income tax because of the NUA tax break.

If Mike immediately sold the stock, he would have to pay only the capital gains tax on that $800,000 NUA. Let's say that Mike instead holds the stock for a few months before selling it. When he sells, he pays capital gains tax, rather than income tax, on the NUA before he transferred the stock to his brokerage account, and on any additional appreciation since then. And because the stock is not a part of an IRA, he does not have to worry about RMDs from the account, based on the stock's value.

Also, if Mike does not roll the stock into an IRA, his beneficiaries, too, would get a break. If they sell immediately, they'd benefit from a step-up in basis to the value of the stock when Mike died. Consequently, they'd pay capital gains tax only on any appreciation in value between Mike's death and their sale of the stock, and not on the $800,000 the stock appreciated in value over the time that Mike owned it.

Let's summarize the difference between Mike not rolling his 401(k) assets into an IRA (taking advantage of the NUA tax break), and Mike rolling into an IRA. We'll assume that he is in the 35% tax bracket.

Here is the comparison if Mike immediately sells the stock:

Say Mike doesn't sell immediately and keeps the stock in the brokerage account. The value increases to $1.5 million in five years, and then he decides to sell.