There are some who are familiar with how Net Unrealized Appreciation (NUA) works as per relationship with the company stock owned by their 401(k) and some, sadly, are not familiar with it.
As a brief explanation, you can take out funds from your 401(k) and rollover everything except the company stock (your company) to an IRA. Then, what you do with the company stock is put it to a taxable account. When you do this you will pay tax on the basis of the company stock and pay tax on the capital gains for the sale of the company stock in the future. This will be the case if the company stock is not within a Traditional IRA. If it were in a Traditional IRA you would have to pay ordinary income tax.
Roth IRA Rollovers
Now, how will things be if you were to roll it over to a Roth IRA account? Generally you would have to pay tax on cash distributions, but if you put the funds in a Roth account, and you meet the qualifications, you won’t have to pay tax on it in the future.
At one time it was treated as a loophole in which you can use both sides of the coin and enjoy the tax incentives that it gives you. Converting company stock directly to Roth would allow an individual, seemingly, to just have to pay tax on the basis as per NUA rules and never to pay tax on the capital gains because the stock is held by a Roth IRA account.
Unfortunately, the Internal Revenue Service (IRS) quickly figured this one out. In the year 2009, after the Roth conversion rules for a qualified plan was put into effect, the IRS made a rule for this specific circumstance. You can not directly rollover a company stock to Roth but rather roll it over first to a Traditional IRA and then convert it to a Roth IRA. There is but one exception to this, the cream in the coffee rule. This rule allows you to consider only the qualified plan’s funds that you want to convert instead of considering all of your IRA’s.
Using IRA Conversions
Conversions to an IRA will result to you having to pay ordinary income tax on the entire value of the company stock holdings rather than just the basis. So enacting the NUA rules and put the company stock to a taxable account might be a more practical way to handle it.
But we all know that Roth IRA offers unique tax advantages and that’s why it has been the most popular choice of many Americans to date for their Individual Retirement Accounts. There are many discount brokers that operate online and offer very competitive Roth IRA rates. Some would even have no fee Roth IRA with their line of services.
There are so many things that you need to consider aside from Roth IRA fees when you choose the best discount broker to be with. So it is better to consult with a financial advisor for this matter.
Just in case you would still want to push through on rolling over your company stock to an IRA, the Roth IRA deadline for converting from a Traditional IRA is on Dec. 31.