Pitfall 5: Highly Appreciated Company Stocks

From AIG Funds

Rolling these stocks into an IRA can cause you to miss out on a valuable tax break!

Rollover mistakes - rolling company stocks

If you have highly appreciated company stock in your employer-sponsored plan, it may be a mistake to roll the assets into an IRA or IRA funded by variable annuity. That’s because a rollover will cause you to miss out on the Net Unrealized Appreciation (NUA) strategy—a distribution strategy that can offer a potential six-digit tax break!

Here’s how it works.

  • Roll the employer stock from a 401(k) into an IRA.  You won’t pay income tax at the time of the rollover, but you must pay ordinary income tax of up to 35% on the entire distribution amount when the stock is eventually sold. Text Box: Click here to see an example of how the NUA Strategy works

  • By using the NUA strategy and transferring the highly appreciated company stock into a taxable account (such as a brokerage account or mutual fund), you will pay ordinary income tax on the stock’s original purchase price (also known as the cost basis) at the time of the distribution. The net unrealized appreciation—the difference between the stock’s original purchase price and its market value on the distribution date—is not taxed until the stock is eventually sold. 

  • Once the stock is sold, you will only pay a maximum capital gains tax rate of 15% on the NUA, not the maximum ordinary income tax rate of 35%! Please note that these tax rates are based on current tax laws and may be subject to change.