Determining Whether To Exclude Employer Stock From A 401(K) Rollover

Many companies add an additional matching amount to 401(k) contributions made by employees. However, the employer contribution sometimes consists of stock in the company itself, resulting in a 401(k) portfolio that is heavily invested in a single stock. Employees who hold stock in their employer through a 401(k) plan may receive preferential tax treatment on a stock distribution by not rolling the stock over with the rest of their 401(k).

Owning a large amount of a single stock results in a lesser degree of asset diversity. As retirement approaches, you are likely to become more concerned with stock value than with the personal satisfaction of owning your employer's stock. Before deciding to include your employer's stock in a rollover, it is best to determine if excluding the stock might be a better option due to its appreciation in value.

Division of 401(k) assets

The tax code allows a 401(k) owner to transfer the stock of their employing company to a regular investment account and roll over the remainder of the 401(k) to an IRA. Your cost basis in the company stock is taxed as current income, but the other 401(k) assets retain their tax-deferred status. The unique advantage of not including the stock transfer in a rollover is that the appreciation in the value of the stock while in your 401(k) is taxed later at a capital gains rate.

Stock price appreciation

After a typical rollover of a 401(k) account to an IRA, funds are not taxed until eventually withdrawn from the IRA. At that point, distributions are taxed at ordinary income rates. In contrast, the transfer of your employer's stock to a taxable brokerage account is not a rollover. The stock transfer is considered to be a taxable 401(k) distribution, but only to the extent of your cost basis. Tax on the net unrealized appreciation is deferred until the stock is actually sold.

Deferral of tax on stock price appreciation

When eventually sold from the brokerage account, any appreciation in value during the time the stock was in your 401(k) is automatically taxed as a long-term capital gain. Any gain after the time of the transfer to the brokerage account is taxed as short-term or long-term capital gain, depending on how long the stock is held in the account.

Excluding employer stock from a 401(k) rollover may produce a lower tax rate if your intention is to sell appreciated stock fairly soon after the transfers occur. Contact a financial adviser, like one from Family Financial Partners, for advice on the additional variables at work in planning a 401(k) rollover.