How do I minimize the amount of taxes I pay when I sell shares from a former employer's 401(k) plan?
I am 34 years old and I have company shares from a former employer's 401(k) plan in a brokerage account. I left the company five years ago. The companies' shares have significantly increased in value over the past 12 months. I'm skeptical if the shares will hold their value in the future, and I believe I should sell high and move the funds into my IRA. I know that if I sell the shares, I face tax implications. I'm trying to determine whether I should attempt to sell the shares, and if so, what is the best way possible to minimize the amount of taxes I am required to pay?
I am assuming that by “Company Shares”, you mean that you have company stock in your 401(k) and that is what you are talking about. If that is the case, and if you are worried about the tax and/or loss in value in those shares, here are your options:
- Sell the shares while still in your 401(k) - that addresses risk and there will be no tax on the sale.
- Roll the shares over to your IRA...depending on what you want to do (and which company it is, you can sell, put in stop/limit orders or use some options (put options and collars) to hedge the position.
- Know the rules on Net Unrealized Appreciation (NUA) before doing either #1 or #2 above. If you sell the shares or roll them over, you lose the ability to get the special tax break of having a capital gains treatment under the NUA rules.
To help in this decision, check out two of my articles:
I also talk about this in my Retirement Survival Guide.
Happy to have some good news for your. If you old company shares are in the your 401(K) and you sell them- you won't owe any taxes on the sale. This is as long as you leave the funds in a retirement account. Rolling it over to an IRA also is not a taxable event so not taxes due.
In general I am a big fan of diversity when investing. So not owning a single stock but rather a portfolio should be a good move for you.
Best way to minimize the taxes is make sure you don't pull the money out of a retirement account. Go ahead sell the shares and roll them over to an IRA with a diversified portfolio.
It sounds like you distributed the shares from the 401(k) when you separated from service to take advantage of the Net Unrealized Appreciation (NUA) tax treatment. Good for you. Your tax basis in the shares was preserved but if you now sell them (which may or may not be a good idea), you will owe capital gains tax on the profit.
The maximum long-term capital gains tax rate could be as low as zero if you are a single filer and have Adjusted Gross Income (AGI) under $37,650. The threshold for joint filers is $75,300. For most people, who fall in the 25, 28, 33 or 35% bracket. The rate is only 15%. Only tax payers whose AGI is taxed in the 39.6% bracket, pay 20% on long-term capital gains.
You say the shares are in a "brokerage account" but you do not say how it is titled. If you set it up the right way, as a rollover IRA, at the time you took the shares from the 401K, and this rollover IRA is the "brokerage account" you refer to, then you can sell the shares with no capital gains liability. If instead you took the shares as a distribution to an ordinary brokerage account, and paid income tax in the year you took them, and paid the 10% penalty that is assessed if you do this before turing age 59-1/2 (To all of you reading this reply, this is not a smart thing to do) then you hold appreciated stock and there is no way to sell without incurring taxable gains. However, if you also have other investments at a loss you might consider selling them in the same year, if it makes investment sense, in order to capture a loss that would offset some or all of the gain.
An aside: If you believe that the company is overvalued and may be headed for a decline, don't let taxes stop you from selling. If you don't sell and the shares decline, you'll have a smaller taxable gain but less after taxes. Frankly I'd rather have the big gain.
As noted in some of the responses it depends where those shares sit currently. If they were purchased in your employers 401k AND the whole balance of the 401k was kept in the plan you may be able to use NUA (Net Unrealized Appreciation). To get the best tax treatment you would request a rollover of the assets in the plan AND request NUA treatment for the shares. When this is done you will create a tax event on the cost basis of the company shares and pay ordinary taxes in that tax year on that amount. Those company shares are now moved to an after tax brokerage account while the rollover assets go to an IRA. If you liquidated them immediately then the amount of gain (current stock value minus the cost basis you already paid) would be treated as long term capital gains, 15% for most people. Those capital gains are most often lower than income tax rates and there is your tax benefit.
If you simply rolled them over, sold the shares and then withdrew money at retirement you would likely be paying a higher income tax rate. That's the bottom line on this strategy, paying less now to avoid more later.
Things to consider: How big is the gain in the stock? If your cost basis is $5k and the shares are worth $100k then that's an easy one. But what if your cost basis is $40k? Not nearly as juicy and more costly currently when paying on that cost basis. You would also want to consider what you think your income tax bracket would be in retirement. If it is going to be low then maybe NUA isn't that great. As always you should consult a tax advisor when considering whether to use NUA.