Evaluate distribution options for qualified employer securities

If you invest in employer stock in your 401(k) or other qualified plan, you may be able to reduce your tax bill when you’re eligible to take a lump sum distribution.1  If the securities to be taken as part of a lump sum have appreciated significantly, you may want to consider transferring some, or all, of those securities in-kind to a taxable brokerage account rather than an IRA. By doing so, you may be able to take advantage of favorable net unrealized appreciation (NUA) tax treatment.

The following table compares a direct rollover of the employer securities to an IRA with moving some, or all, of the securities in-kind to a non-qualified brokerage account.

 

 

 

 

Direct rollover2
treatment does not apply
to an IRA — NUA tax

Moving employer stock3
using NUA tax treatment
to a taxable brokerage account,

Benefits

  • No income or 10% early withdrawal penalty taxes owed on the rollover amount
  • Contributed amounts and any earnings remain tax-deferred
  • Wide variety of investment choices
  • Buy or sell shares of any security within the IRA, including the employer stock, without realizing taxable gains or losses
  • Unlimited federal bankruptcy protection4
  • Eligible for a Roth IRA conversion
  • Distributions from the IRA are not subject to the 3.8% tax on net investment income5
  • Pay long-term capital gains tax, instead of ordinary income tax, on any remaining NUA when you sell the stock6
  • Required minimum distribution rules do not apply to the stock after it has been distributed
  • IRS early withdrawal penalties do not apply to the NUA portion of the distribution

 

Considerations

  • IRA distributions are taxed at ordinary income tax rates, not long-term capital gains tax rates (which are lower)
  • IRA withdrawals are subject to 10% tax penalty if taken before age 59½7
  • IRA accounts are subject to required minimum distribution rules beginning at age 70½
  • Other than bankruptcy, creditor protection is determined by state laws4
  • When you distribute shares from the employer-sponsored plan you will pay ordinary income tax on the cost basis of those shares in the plan
  • If you leave service prior to the year you turn age 55 and you are not yet age 59½ distributions of cost basis in the plan may be subject to a 10% tax penalty8
  • Generally, only lump-sum distributions including employer stock qualify for NUA tax treatment9
  • Significant tax advantages may not be realized unless the stock has greatly appreciated while in the plan
  • Loss of tax-deferred status on the cost basis and future dividends of the securities taken in-kind
  • Maintaining diversification while the stock is held
  • Assets generally are not protected from creditors
  • Capital gains above the NUA amount may be subject to the
  • 3.8% tax on net investment income5

 

 

Tax savings comparison

This hypothetical example compares the tax treatment of a direct rollover to moving highly appreciated employer stock. Tax savings will vary based on your personal situation. Other assets are not considered for this illustration. Assumes the following at the time of distribution from the employer’s plan: age 50, employer securities have $25,000 cost basis in the plan, $100,000 current value, 33% ordinary federal income tax rate.

 This is a highly simplified example; Taxes Total taxes
Direct rollover to an IRA — NUA tax treatment does not apply • Current taxes due upon rollover from employer’s plan $0
• Penalty taxes due upon rollover from employer’s plan $0
• Taxes due10 upon withdrawal of cash from the IRA11 $33,000
• Penalty taxes due if withdrawn from the IRA prior to 59½$0 $10,000 $43,000
In-kind distribution to a taxable brokerage account, using NUA tax treatment • Current taxes due on the cost basis in the plan upon moving employer stock from employer’s plan $8,250
• Penalty taxes due12 on the cost basis in the plan upon moving employer stock from employer’s plan $2,500
• Current taxes due13 upon sale of stock from the brokerage account14$8,250 $11,250 $22,000
Potential tax savings due to NUA tax treatment $21,000

 

Commonly Asked Questions

What is a lump-sum distribution?
A lump-sum distribution is a withdrawal of your entire balance in all qualified plans of the same type (e.g., all defined contribution plans), maintained by the same employer within one taxable year. Your prior withdrawals may disqualify you from fully using NUA tax treatment, so ask your plan administrator for your options. Also, using the NUA provision can be complex. Please consult your tax adviser before taking distributions of highly appreciated company stock.
In general, you may take a lump-sum distribution when you reach age 59½. You also may take a lump-sum distribution,regardless of your age, if you leave your employer or for a self-employed person, if you become disabled.
Yes. You can elect NUA treatment for all or part of your employer stock and roll the remaining portion to an IRA.
Shares of stock, bonds or debentures issued by your employer (or a parent company or subsidiary) owned in an employer-sponsored qualified plan may be eligible. Check with your plan administrator. Even though a security is eligible, there is no requirement to use NUA tax treatment.
Currently YUM Brands 401(K) does allow in kind distributions with a qualifying event.
The cost basis in the plan (and any penalties) is taxable in the year in which you take the in-kind distribution(s) of employer securities as part of an NUA strategy.
Heirs are eligible to receive NUA tax treatment on employer securities distributed in-kind from a qualified plan; however, a beneficiary will not receive a step-up in basis on NUA.
A significant decline in the share price of your employer’s stock or an increase in your capital gains tax rate could negatively affect an NUA strategy.

 

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1Other options may be available, such as cashing out, rolling over or leaving the assets where they are. Generally, you may use more than one option.

2To be considered a direct rollover and avoid the 20% mandatory withholding (which helps to prepay taxes), you must have a check or wire sent directly from your former employer’s plan to the IRA custodian, or you may receive a check payable to the IRA custodian.

3When moving employer stock, shares of the employer security are transferred from the employer plan to your brokerage account.

4Federal bankruptcy protection afforded under the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005.

5The 3.8% tax on net investment income applies to the lesser of Net Investment Income or Modified Adjusted Gross Income over $200,000 for single filers
and $250,000 for married fililng jointly. It does not apply to NUA or distributions from an IRA or qualified retirement plan.

6For 2014, long-term capital gains are taxed at 0% for gains in the 10% and 15% tax brackets; 15% for gains in the 25-35% brackets; and 20% for those in the 39.6% bracket.

7Penalty taxes don’t apply to withdrawals made after age 59½ with other limited exceptions.

8Certain exceptions to the 10% early withdrawal penalty may apply. You do not need to take a distribution immediately upon termination of employment to qualify for NUA tax treatment. Therefore, if you are younger than  59½ or under certain criteria, age 55, you may wait until you reach age 59½ to take a lump-sum distribution to avoid the penalty.

9Individuals who have made nondeductible employee contributions may receive net unrealized appreciation on securities attributable to those contributions
without a lump sum distribution.

10 Any available NUA tax treatment is irrevocably forfeited when you roll over employer securities. Taxes, at ordinary income tax rates, are generally due on all amounts (other than after-tax contributions and other basis)   withdrawn from an IRA.

11 Assumes all shares are sold and that the value of the shares is the same when sold as when rolled over to the IRA and the tax rate of 33% continues to apply to the full distribution.

12 Penalty taxes don’t apply to withdrawals made after age 59½ (and with certain criteria after age 55 and other limited exceptions.)

13 When you sell shares, long-term capital gains taxes (assumes 15%) are due on the NUA (current value minus cost basis in the plan).

14 Assumes all shares are sold and the value of the shares is the same when sold as the value when distributed from the plan and the tax rate of 15% continues to apply.