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by Harry Rabb, C.P.A.
Special to Tropical Breeze
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| Harry Rabb, C.P.A |
One of the key lessons learned from the
Enron debacle is that you don't want to invest too much of your
retirement assets in any company's stock, especially if it's the
same firm you work for.
Enron's 401(k) participants had many
investments to choose from. Those who got hurt the most piled into
Enron shares as if placing chips on a single roulette number, then
watched as their account values vanished.
Since Enron, workers have been encouraged
to trim their exposure to employer stock. Nevertheless, plenty of
people still have sizable holdings. And a little-known rule
provides a potential tax benefit.
The rule allows participants in 401(k) and
employee stock-ownership plans to pay lower long-term capital-gain
rates on a portion of their holdings instead of the
higher-than-ordinary-income rates that normally apply.
Investors are eligible when they leave
their firms upon retirement or for other reasons. They must take a
lump-sum distribution of all assets in the account, notify their
plan administrator and elect "net unrealized appreciation" —
or NUA — tax treatment.
This tax break applies only to employer
stock, not other investments in a retirement plan. Specifically, it
applies to that portion of stock representing appreciation or paper
gains, not the "cost-basis" portion reflecting original
contributions.
This is something most individuals have
never heard of and the rationale is when an employee holds company
stock, additional risk is assumed.
It is not suggested that workers load up
on employer shares in their ESOP or 401(k) plans just to reap this
benefit, as that could make investment accounts highly
volatile.
Several factors affect the decision on
whether to elect NUA treatment. But in general, the greater the
proportion of unrealized gains and the more stock owned, the bigger
the benefit.
As noted, you must distribute your entire
401(k) or ESOP account as a lump sum if you seek this tax break.
But you don't have to spend it all and can reinvest remaining
proceeds in different assets within an Individual Retirement
Account or elsewhere, helping to diversify your portfolio mix.
All in all, NUA treatment can offer a nice
tax savings for some people at or nearing retirement — even
if it is treacherous to have loaded up on employer stock in the
first place.
Workers who leave their employers upon
retirement or for other reasons can lessen the tax burden on the
profits on the company stock in their retirement accounts by
calculating the "net unrealized appreciation" in their nest
egg.
This example should demonstrate how NUA
treatment works:
Suppose you have $100,000 in company stock
in your 401(k) — $20,000 in contributions and $80,000 in
price appreciation. Further, suppose you've reached retirement age
and fall in the 35 percent tax bracket.
With NUA treatment, you would pay an
ordinary-income tax rate of 35 percent on your $20,000 "basis"
amount and a 15 percent capital-gain rate on the $80,000 in
gains.
That comes to $19,000 in total taxes,
which is a whopping $16,000 less than if you pulled all the money
out as a regular distribution and paid ordinary income taxes.
As always, please consult with your tax
professional before implementing a strategy. Usually, an investment
decision made for tax reasons will not yield the benefit
expected.
• • •
This information is provided as a public
service and should not be construed as individual accounting or tax
planning advice. For information on how these general principles
apply to your situation, please consult an accounting or tax
professional.
Harry Rabb is a C.P.A. and owner of
Accounting Services, Inc., 935 Main Street, Suite D-1, Safety
Harbor. Call 727-725-4121.
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