Military Officer - August 2007 - (Page 44)

financialforum Stock Rollovers Moving company stock out of a retirement plan can be a costly experience. Phil Dyer, CFP, takes a look at a little-known tax rule that could help ease your tax burden. I NUAs and Capital Gains Tax Treatment ■ After distribution, any net unrealized appreciation sale is subject to long-term capital gains tax rates, and any future appreciation in the stock is subject to short-term capital gains tax rates unless held for at least 12 months, at which point they become long-term capital gains as well. f you have a significant amount of company stock within your secondcareer 401(k), you should be aware of a little-known tax rule that can signiﬁcantly lower your taxes on company stock within your retirement plan — but only if you plan carefully and follow the correct process when you get ready to retire. IRC § 402(e)(4) governs net unrealized appreciation (NUA) rules and provides company stock held within a retirement plan with special tax treatment if the stock is distributed directly from the 401(k) or similar retirement plan into a taxable brokerage account via a “like-kind” exchange. The distributed stock is only taxed on the basis (what you paid for it within the plan), not on the current fair market value (FMV). The balance of the stock value is not taxed until the stock is sold, and it is not subject to early withdrawal penalties. Let’s give an example of how this works. Jim is a retired Navy commander who has worked for ABC Defense Contractor since retiring from active duty in 1989. He plans to retire in October 2007 and has built up a 401(k) plan worth $1.2 million. Included in the plan are 10,000 shares of ABC stock, currently worth $500,000 ($50 a share). If Jim rolls his entire 401(k) balance into a brokerage account, then all future distributions will be subject to ordinary income taxes. But let’s assume Jim’s cost basis in ABC Defense Contractor is $8 a share, since the company has gone through several stock splits. This means Jim’s basis in the $500,000 worth of ABC stock is only $80,000 and he has an NUA of $420,000 ($500,000 FMV minus the $80,000 cost basis). Assuming Jim is now in the 35-percent federal tax bracket, it would cost him $28,000 in taxes ($80,000 x 0.35) to execute a like-kind exchange of the employer stock into a brokerage account. The NUA portion of $420,000 is now subject to capital gains tax rates, with a current maximum rate of 15 percent. How much does this save Jim? Assuming his retirement federal tax bracket will be 30 percent, he would pay $150,000 in ordinary income taxes ($500,000 x 0.30) to withdraw the value of ABC stock from a rollover IRA. Under the NUA rules, Jim’s tax burden is the $28,000 from the original distribution, plus a maximum of $63,000 ($420,000 x 0.15) in long-term capital gains if he immediately liquidated the entire account — a savings of $59,000! Also, because the stock is now in a taxable account, it’s available for charitable gifting and receives a step-up in basis on Jim’s death. This technique works best with low basis stock where you can afford to pay the taxes to support the like-kind exchange. Consult your tax advisor to see whether it’s right for your particular ﬁnancial situation. MO — Former Army Capt. Phil Dyer, CFP®, is deputy director, Beneﬁts Information and Financial Education. To ﬁnd a ﬁnancial planner near you, contact Garrett Planning Network at (866) MOAA-GPN (662-2476) or www.moaa .org/garrett, or visit www.moaa.org/ﬁnancial center for other resources. PHOTO: SEAN SHANAHAN 44 MILITARY OFFICER AUGUST 2007 http://www.moaa.org/garrett http://www.moaa.org/financialcenter http://www.moaa.org/garrett http://www.moaa.org/financialcenter

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Military Officer - August 2007 Contents From the Editor From the President Your Views MOAA Directory Rapid Fire Washington Scene Financial Forum Ask the Doctor Chapter Activities Cover Story: No Longer in Reserve A Different Path Weird Science Charge? Pages of History Faces of MOAA Member Books Information Exchange Advertising Index MOAA Calendar MOAA Scholarship Donors Sounding Taps MOAA Member Services Encore

Military Officer - August 2007

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