Company stock within 401(k) plans
It is not uncommon for individuals to hold a position in company stock within their 401k plans. These shares are often held alongside broader fund investments usually until an individual either leaves employment with the company or retires.
Typical distributions from your 401k plan will be taxed at income tax rates based on your total taxable income in the year of withdrawal. However, when you hold company stock within your pension plan, the appreciation within the shares are known as net unrealised appreciation (NUA) and, if dealt with properly, can attract more favourable tax treatment at distribution.
NUA can be defined as the gain held within a company stock position. In other words, it is the difference between the current fair market value of the position and the original purchase price. At distribution, the company shares can be rolled into an IRA or can be transferred into a taxable account.
In the instance that the shares are transferred into a taxable account, income tax treatment will be limited to the portion of the position that represents the original purchase price of the shares, or to the cost basis. Then, when the shares are subsequently sold, the NUA will be taxed at long-term capital gains rates as opposed to income tax rates which is generally more favourable.
Some of the broader factors that help determine the overall impact of trying to take advantage of NUA treatment have to do with the relative proportion of gain in the position versus cost basis and the differential between your income tax rates and the more preferential capital gains tax. Generally, the larger the unrealised gain within the position and the higher your overall income tax rates are, the more beneficial the NUA treatment will be.
The choice of taking advantage of NUA treatment is not always straightforward. It is very important that you ensure you meet all of the criteria required to take advantage of the treatment and it is very important to consider the opportunity in the broader context of your financial situation. Tax advice should be sought to determine how to best apply the treatment to your individual circumstances.
For more wealth planning tips and tidbits from MASECO read our 39 Steps to Smart Living in the UK.
Risk Warnings and Important Information
The value of investments can fall as well as rise. You may not get back what you invest.
The above article does not take into account the specific goals or requirements of individual users. You should carefully consider the suitability of any strategies along with your financial situation prior to making any decisions on an appropriate strategy.
MASECO LLP trading as MASECO Private Wealth is authorised and regulated by the Financial Conduct Authority, the Financial Conduct Authority does not regulate tax advice. MASECO Private Wealth is not a tax specialist. We strongly recommend that every client seeks their own tax advice prior to acting on any of the strategies described in this document.