How To Roll Over Your Company Stock From a 401k

You may or may not be familiar with the concept of Net Unrealized Appreciation (NUA) as it relates to company stock owned in your 401(k) plan.  Click the link to get a rundown on it if you’re not familiar with NUA.

Briefly, when you take distribution from your 401(k) you can rollover everything but the company stock (your company) to an IRA, and then put the company stock in a taxable account.  By doing this, you pay tax only on the basis of the company stock, and in the future you will only have to pay capital gains tax on the sale of the company stock, rather than ordinary income tax as you would if the company stock (or the proceeds) were in a traditional IRA.

[See Jim’s tips on Paying Taxes on a Roth IRA Conversion]

Now, let’s toss in the Roth Conversion concept – you pay tax on the amount that would be otherwise taxable if the distribution were in cash, but you place the funds in a Roth IRA account, and you don’t have to pay tax on it in the future at all (as long as you meet the qualifications).

How do these two concepts work together?  Well, at one time, it was thought that you could work both sides of the coin and utilize the loophole:  if you converted the company stock directly to the Roth, it seems that you would only have to pay tax on the basis of the stock (per NUA rules), and then never have to pay tax on the capital gains.  This is because the stock is held in a Roth IRA.

Not so fast, though.  The IRS figured this out pretty quickly after the rules for conversion from a qualified plan to a Roth IRA were put into effect in 2009.  For this specific circumstance, you must treat the Roth conversion from a qualified plan as if it were first rolled over to a traditional IRA, and then converted to a Roth IRA.  The one exception to the way this is handled is that you only have to consider the qualified plan’s funds that you’re converting – rather than all of your IRAs as you would normally (cream in the coffee rule) – for tax purposes.

This results in having to pay ordinary income tax on the entire value of your company stock holdings if you do such a conversion (rather than just the basis).  So it may still be to your benefit to enact the NUA rule and put the company stock into a taxable account rather than an IRA – but you’ll have to run the numbers to figure out if this will work best for you.

About the author

Jim Blankenship, CFP®, EA

Jim Blankenship is the founder and principal of Blankenship Financial Planning, Ltd., a financial planning firm providing hourly, as-needed financial planning and advice. A financial services professional for over 25 years, Jim is a CFP professional and has earned the Enrolled Agent designation, a designation that qualifies him as enrolled to practice before the IRS. Jim is also a NAPFA-registered financial advisor, which designates him as a Fee-Only Financial Advisor.

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6 Comments

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  • Gregg,

    If the stock was sold, you are out of luck unless you have proof that your request was for distribution of the stock in kind.

    If I understand your question, yes you can put the funds either back in the 401(k) or into an IRA – but you’ll have to make up the difference on the withholding amount since that was sent to the IRS. If you don’t you may wind up with a 10% penalty on that amount even though you’ve done a rollover as the end result.

    I’m also pretty certain that I’m not fully understanding your question, so if you have additional questions after my above explanation, please send them and I’ll try to help you out.

    jb

  • I left one job for another on 1/1/12. I had a 401k that had total value of $215,966 which included $21,140 of company stock. I requested a cash out of $21,825 and a roll over of the company stock. What happened is a cash out of $21,825 plus the current value of the stock ($21,140) minus the NUA ($4,390) for a total reported income of $38,576 from the cash out. 20% federal tax was witheld from the $38,576. Is it too late to roll the stock back to a tax defered status? If I can defer the stock tax liablbity by rolling it over what about the income tax reported to the Gov. and the extra tax withheld?

  • Gary –

    Most of the time ESOP plans are not qualified, that is, tax-deferred plans. (I say most of the time because occasionally company stock purchases within a 401(k) plan may be referred to as ESOP.)

    The traditional ESOP plan – where you make regular contributions through payroll deductions to purchase stock in your company at a discounted price, with the agreement that you’ll hold the stock for a period of time (usually about two years) – is a taxable account.

    As such, you will not be able to simply deposit any amount from the ESOP into an IRA or a Roth IRA. You could make annual contributions into those accounts with proceeds from the sale of stock in the ESOP account, however.

    Taxes on the sale of the stock in the ESOP will be at capital gains rates (under today’s law) and would only be due on the value of the stock over the basis (the amount you paid), and would be due for the year that you make the sale. In the case of your example, on your 2011 return, due in April of 2012.

    Hope this helps –

    jb

  • Jim,
    I am in my mid-20’s and I do not have a whole lot if knowledge on the differences between a traditional IRA and a Roth IRA. I was recently laid off from a company in which I was vested 80% into their ESOP plan. I received a statement showing my vested percentage was close to 36k and I am trying to figure out what to do with it. I have a 401(k) with my current employer; however it will not allow me to roll over company stock. What I want to do is take 10k out (I am buying a house and would like to have some extra cash to fix the place up) and then put 26k into an IRA. What I am confused about is the taxes. I understand if I open up a traditional IRA, I do not have to pay the taxes up front, but I have been leaning toward a Roth IRA so I do not have to pay the taxes when I am in a higher tax bracket later on in my career. If I proceed with the Roth, will I have to consider both the 10k and 26k as taxable income when I file in 2012? I make around 60k salary, so I’m assuming that would raise my tax bracket which I do not want. What would you recommend?

  • Val –

    I don’t know for certain, but SIRP could stand for Supplemental Income Retirement Plan (or something along those lines). Based on how the cash-out was treated, I imagine this was a non-qualified compensation deferral plan, and so that description would fit.

    Not to take this lightly, but there’s bad news, and more bad news, if this was indeed a non-qualified compensation deferral plan.

    The first bad news is that you have no choice, you will have to claim the cash-out as income in the year that it was cashed out. Often this can cause additional problems with your tax return, pushing your Adjusted Gross Income above limits for various deductions and credits, for example.

    The second bit of bad news is that you can’t rollover these funds into an IRA or another 401(k). Your best bet would be to establish a taxable account and place the funds there – perhaps gradually funding Roth IRAs over time…? Otherwise, paying off a loan might make good sense if it will have a profound impact on your lifestyle – but I’m in agreement with you on the “two mortgage” question. That rarely works out well.

    Sorry to be the bearer of bad news. I hope I’m wrong. You can check with the company that was the custodian of the account to be sure.

    Best wishes to you –

    jb

  • My husbands SIRP (whatever THAT is) was cashed out after he quit the company he was with for 15 years. The SIRP was automatically cashed, he was NEVER asked, never authorized the cash out of $145K…so I opened the envelope to see $100K (minus the $45K paid in stupid taxes)….we don’t know what to do with his $100K.
    He lives in Dallas. I live in Atlanta for now until our house sells.
    He wants to take his $100K and put down on a house in Dallas IF ONLY our house in ATL can be rented out or sold. But I don’t want to have 2 mortgages and neither does he. I said to him, that money was for retirement, put it back into something where you won’t get taxed too heavily again. HELP! We honestly don’t know what to do…and paying more taxes like the $45K is not an option.

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