Avoiding Mistakes With Company Stock in Your 401(k)

In another article on this site we discussed the concept of Net Unrealized Appreciation,  or NUA for short.  It’s a complicated affair, fraught with potential mistakes – several of the most important ones are listed below.  Net Unrealized Appreciation (NUA) refers to the increase in value of your company’s stock held within your 401(k), either due to a company match or your own investment in the company stock within the 401(k).

Mistakes With NUA

left by srslyguysMoving too quickly – if you roll over your funds from the Qualified Retirement Plan (QRP) without first checking to see if there can be a benefit from the NUA treatment of company stock in the QRP, you’ve lost the chance to do so.  Always check for NUA possibility within the QRP before making any rollover moves. Not moving quickly (completely) enough – if you have determined that NUA treatment can benefit your situation, you must move ALL of the funds from the QRP within the same taxable year.  If you moved your NUA stock out first and planned to rollover the rest of the account into an IRA or other employer plan, you must follow through within the tax year – delaying even one day beyond the tax year end will break the NUA option and cause the distributed stock to be fully taxable. Taking RMDs in an earlier year – if you retired in an earlier year, and began taking Required Minimum Distributions (RMDs), once that tax year ends and you have not taken your Lump Sum Distribution to enact the NUA option, you no longer have the NUA option available to you.  This is due to the fact that the NUA option is available ONLY after a triggering event, and the entire balance must be withdrawn in a single tax year.  If another triggering event were to occur – disability or death – then the NUA treatment could still be available. Selling out of NUA-potential stock in the QRP – if you have significant holdings of your company’s stock in your QRP, chances are at some point you’ll get nervous about holding too much stock in a single company.  Obviously, you don’t want to overexpose yourself to a volatile stock – but it may not make sense to sell all the stock, either.  If the stock has appreciated over a significant period of time, you might want to maintain a position simply to take advantage of the NUA treatment. On the other hand, if you’re concerned that the stock is going to drop like a rock, (remember Enron? Worldcomm? CitiGroup? Countrywide?) you should ignore the concept of NUA altogether – you shouldn’t let tax laws wag the financial responsibility dog.  Besides, if the stock drops there wouldn’t be any NUA treatment anyhow. Not understanding NUA – if you don’t understand it completely, your chances of getting it right are small.  This is a very strict set of rules (aren’t they all though?) and simple moves in the wrong direction can break the option altogether, potentially causing a major tax hit.  It’s also important for your heirs to understand NUA – or make sure that they will work with your NUA-savvy advisor before they make any moves.
Photo by srslyguys
IRS CIRCULAR 230 NOTICE: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (or in any attachment) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in this communication (or in any attachment).

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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  • Jim,
    I left a company this year and have a large amount of my 401K in that’s company stock. They did a “Special dividend ” and it was paid directly to me in a check out of my 401K. Is this subject to the 10% penalty or only normal Income Tax rates? Thanks Sir…

    • That’s a great question to ask the 401k administrator. Did you have the option to receive the dividend in the 401k plan? If so and you chose to receive the funds in cash then I don’t know how you would avoid the penalty for an early distribution, unless it meets an exception somehow.

  • I retired in May of this year. I have the option of receiving the dividends from the company stock in my 401K or putting these dividends into the 401K plan. I elected to receive the dividends in June of this year.
    Does this affect me using the NUA option?
    Because I did this, must I take a lump-sum distribution this year in order to utilize the NUA option?
    I am 67 years of age.

    • The division of my parent company is being sold to another company. I will move my 401k from old company to the new one. I have company stock in my current employer’s 401k, but am told that I cannot move that stock to the new company 401k. So I have to either leave it with my current company or liquidate.

      I am 75 years old and plan on continuing to work for a couple of more years. Since I am now at the age that I must take Required Minimum Distributions from my IRA accounts, I am trying to avoid having to take RMDs from the money I have tied up in current company stock.

      Literature from my current company discusses the NUA tax rule, but it is clear as mud to me.

      • You should be able to take advantage of the NUA rule with your company stock, but you’ll need to do it during the same calendar year that you transfer the remainder of your current 401k to the new 401k.

        Regarding clearing up how it all works, I don’t think I could get into that here – there are lots of articles and guides on how it all works, including a few here on this site. Then you can find a trusted advisor to work with to help you through the process, if need be.

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