Company stock in 401K

[Guest jc7032]

Can someone please summarize the tax consequences of early withdrawl of company stock held in a 401K ? Is it true that the valuation for tax purposes is the cost of when the stock was originally purchaced? If that is so, is it an advantage for highly appreciated stock to withdraw the stock, pay the penalty for early withdrawl, then hold the stock for a year in order to get taxed at the lower 20% long term capital gains rate? The 20% rate would be lower than any income tax rate that would be applied at retirement. I would appreciate any advice / insight into this. Thanks.

[Guest Harry O]

Assuming your early withdrawal of stock is in the form of a qualified lump sum distribution (or you are withdrawing stock attributable to after-tax employee contributions)before age 55:

1. The basis of the stock (the amount the trust paid to purchase the shares) is ordinary income (except to the extent attributable to employee after-tax contributions),

2. The amount included in income under #1 is subject to the 10% early distribution penalty,

3. The appreciation in value while the stock was held in the trust is called "net unrealized appreciation" (NUA) and is not taxed at distribution and is not subject to the 10% penalty tax,

4. If you immediately sell the stock, the NUA is taxed at long-term capital gains rates and is not subject to the 10% early distribution penalty,

5. If you wait to sell the stock until some time after distribution, the NUA is taxed as long-term capital gains and any post-distribution appreciation is taxed as either short-term or long-term capital gains depending on whether you held the stock for more than one year after distribution.

As you can see, NUA provides a nice way to minimize early distribution penalties. If you sold the stock inside the plan and received the cash proceeds, the entire distribution would be ordinary income subject to the 10% penalty (except to the extent attributable to employee contributions).

By taking shares in-kind, you can immediately sell the stock and the NUA portion gets the benefits of long-term capital gains rates and avoids the 10% penalty.

[Kirk Maldonado]

Harry O did a good job of summarizing the tax consequences. One warning, though. If the benefit is rolled over into an IRA, all of the special tax benefits he mentioned are lost.

[Guest jc7032]

Thank you very much. I appreciate the info. As a follow-on question, if I can't move the money to a rollover IRA without losing the advantages, do I retain the advantages if I leave it in the original employer's 401K program after I leave the company? Can I still withdraw the stock (with the advantages intact) years after I cease being an employeee - and having started another 401K with the new company? Thank you for the very helpful information.

- JC

[LCARUSI]

jc7032 -

Yes to your question:

"do I retain the advantages if I leave it in the original employer's 401K program after I leave the company? Can I still withdraw the stock (with the advantages intact) years after I cease being an employeee - and having started another 401K with the new company?"