Forbes Best-In-State Wealth Advisor, Cary Stamp, CFP® of Jupiter, FL, illustrates the huge tax advantage of using the Net Unrealized Appreciation strategy when distributing your employee-owned stock.
My name is Cary Stamp. I’m a certified financial planner and founder of Cary Stamp & Company. And if you are an employee of a large corporation that has stock as an offering, either in your 401k plan or some other type of retirement plan, I am talking to you. And please listen to what I have to say because it could prevent you from making one of the biggest mistakes of your life.
I’m going to talk about a strategy that’s called Net Unrealized Appreciation. Net Unrealized Appreciation gives employees of major employers, and down here in South Florida, we work with a lot of people that have been employees of Universal Technologies or their legacy companies, Florida Power and Light and other major employers down here in the South Florida market. If that applies to you, listen up.
The Net Unrealized Appreciation strategy allows you to take the company stock that’s in your 401k or retirement plan and distribute it from your retirement plan in a unique tax-saving method.
Let’s say that you’ve worked at a particular employer, say down here, it’s one of the United Technologies’ spin off companies like Carrier. And you’ve, over the years, put substantial money in your 401k plan in the company stock. In the company stock, let’s say that you have half a million dollars of company stock. Well, you’re going to have some choices when you retire.
You can leave it in the retirement plan, take money out as you need it and sell it and pay tax in ordinary income tax rates, or you can roll it over to an IRA when you retire and then from the IRA you’re going to take money out, pay tax at ordinary income tax rates. I’m going to show you a way that you can pay a lot less tax.
So, half a million dollars is what you’ve got value in your Carrier stock in this example. But over the years you’ve been investing in the stock and your basis was only $100,000, which means the stock went up. You put $100,000 into the stock while you were working at that particular company, but because the value of the stock increased, it’s got a much higher valuation. What can you do? Well, you can elect at the time that you separate from service or retire from that particular employer, to take a distribution of the stock from the plan. If you so elect, you will pay tax on the basis, at that particular moment. You’ll pay tax on $100,000 at ordinary income tax rates. So for a typical person, that could be somewhere in the mid 20% or low 30% tax rates on that $100,000, not on the full $500,000 that you’re actually going to take out of the retirement plan.
Now, you’re going to take the stock and you’re going to put it in an investment account. And as you sell the stock off, you are going to pay capital gains tax rates on the stock that you’re selling off. So on the difference on the $400,000 as you sell the stock, if your income is less than $80,000 a year at the time of your retirement, how much is the capital gains tax rate for a married couple? Zero. You will pay no capital gains rate if you’re below the threshold to pay capital gains.
If your income is between $80,000 and half a million dollars a year, you’ll pay a 15% capital gains rate on the stock that you’re selling instead of the ordinary income tax rate on the $400,000, had you chosen to pull it out of an IRA.
There are a few things that you need to keep in mind. One, this has to be done as part of a lump sum distribution. This means that when you’re retiring, you have to take all of the assets out of the retirement plan and you roll the stock out and into your investment account. If there are other assets in that retirement plan, make sure that those get rolled into an IRA or you will pay tax on that distribution for the full amount. This only applies to the company stock.
Another thing, the benefit is substantial when you’re over 59-1/2. If you’re under 59-1/2, there’s still some things that you can do here, but if you pull the stock out, you’ll be subject to the 10% penalty for early withdrawal from a retirement plan. If you are a younger person working at a company like this, think about this because you may want to accumulate a significant amount of your wealth in company stock. What does that mean? That means don’t trade the company stock. So if you think that it’s gone up a lot and you think, oh, geez, I’m going to sell it now and wait for it to go down and then I’m going to buy it again, you may be shooting yourself in the foot and you won’t be able to use this strategy when you retire because you have to take out the full amount of the appreciation, and usually that comes from a situation where somebody has owned the stock for a significant period of time.
This is tricky. Talk to us, talk to your accountant, talk to your tax advisor. We’re here to help.
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