I always like to pay my fair share of taxes, but not more than is necessary. Do you feel that way, too? Don't you hate it when you find out that you paid more taxes than you could have?
Here is one situation you should consider.
You may be ready to retire. Perhaps your company has given you the option to take a lump sum distribution of your plan and you are thinking about rolling your money over to an IRA account so that you have more investment options available. Are you in this situation? Or will you be at some point in the future?
Maybe you worked for a company which gave you the option to buy their company's stock as one of your investment options, and the stock has gone up in value considerably since you originally purchased it.
If that is the case, stop and consider this option before you roll all your assets over to an IRA account.
There is a strategy you may be able to take that allows you to pay ordinary income tax on the amount you originally paid for the stock (its cost basis) instead of the amount it is worth today. But there are very special rules you must follow to take advantage of this strategy.
The difference between the price you paid for your company's stock and the current market value is called net unrealized appreciation (NUA).
So, let's say you worked for IBM for thirty years, and you invested in IBM stock in your plan. You are now 60 years old, and you are planning to retire from the company.
You now hold 5,267 shares of IBM stock in your company plan. It is now worth about $1,000,000 based on the current market value, but the average price you paid for it over the years was only $300,000. Let's say you also own a variety of mutual funds in your plan account and the total value of your plan assets is $2,000,000.
So, for your IBM stock, the NUA is $700,000. So, let's say you retired on July 1, 2014 and you now want to roll your plan assets over to an IRA account. If you roll over your entire account to an IRA, and take a distribution of the entire amount, you will have to pay ordinary income tax on the entire $2,000,000.
However, let's say you decide move your 5,267 IBM shares to a regular individual account (not an IRA account), and roll the other $1,000,000 worth of mutual funds to an IRA account all in tax year 2014.
You then decide to take a distribution of the entire $1,000,000 you rolled over to the IRA account. You would pay ordinary income tax on $1,300,000.
When you later decide to sell your IBM stock, you will pay long term capital gains tax (not ordinary income tax) on the difference between the $300,000 cost basis and the market price of the stock when you sell it.
On a $700,000 gain, that is a big savings. For instance, if you incurred a 20% tax rate savings on this amount, that could put another $140,000 in your pocket. That's nothing to sneeze at.
Or you may even decide to donate some of the appreciated stock to a charity and take a deduction for the market value of the stock when you gift it to the charity.
Remember, this strategy makes sense only if the value of your company's stock has gone up considerably since you purchased it. So, if that is the case, make sure that you take a look at this strategy before you decide to roll over your assets to an IRA account.
Once you roll over your stock to an IRA, it is too late. You can't change your mind and later decide to use this strategy. You would then have to pay ordinary income on the entire amount.
There are very specific rules you must follow to take advantage of this strategy, and not every situation has been discussed here. So, you must get competent advice for your individual circumstances before you implement this strategy.
For instance, you must be able to take a distribution of the entire balance in one taxable year. It cannot be used with an in-service withdrawal.
You must meet certain criteria, which can include situations such as: