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$128,284 in Taxes Saved

Monday, April 28th, 2008

When Charlotte was about to retire after 28 years of service with a large telecommunications company, her husband was ready to put her retirement plans in a rollover IRA and start buying mutual funds. She had witnessed the ups and downs their portfolio had gone through under his watch, and decided to get some professional advice from us before she signed the transfer papers.

Within her 401(k) and her ESOP she had $975,000 in company stock

The company stock was purchased over her 28 years as an employee, with an average cost of $23, the current price (after numerous splits) was $100. If Charlotte chose a split distribution (that is, sending the company stock to a regular brokerage account as a taxable distribution and the remaining assets to an IRA as a tax deferred distribution) she can get HUGE tax advantages.

The tax bill of $78,490 (9,750 shares at the $23 cost = $224,250 x 35% = $78,490) seemed high and she would have to sell some shares in order to pay the tax. However, in her case, it was a small price to pay.

When she sells the shares (let’s say for $100), her tax cost is now $78,490. Anything over this is taxed at long term capital gains rates. So, by taking advantage of NUA (Net Unrealized Appreciation) her taxes are $212,966 (9750 shares X $100 – $78,490 = $896,510 X 15% = $134,490 + $78,490). Charlotte has $762,034 net after taxes.

Compare this to leaving the shares in the IRA, selling for $975,000 (9,750 shares X $100) and then withdrawing from the IRA and paying ordinary income tax rates. Let’s assume 35%. Now Charlotte’s taxes are $341,250! Leaving her only $633,750 net after taxes.

By taking advantage of NUA, Charlotte saves $128,284 in taxes! Assuming she earns 6% on this tax savings, in 10 years she has an extra $227,262!!

Warning: NUA IS NOT FOR EVERYONE!!!

Electing to take separate distributions and pay the current income tax is not for everyone. If the stock has not appreciated very much, it is probably not worth such an election unless you intend to keep the stock and you have good reason to expect good future performance.

Be careful, not all plans allow for separate distribution: some plans require all the money to go to an IRA rollover or the entire amount to be a taxable distribution. If this is the case, you will run into the 20 percent withholding rule, which may be tough to deal with. This problem exists more with 401(k) plans than with ESOP plans. If a split distribution is allowed in a 401(k) plan, most companies do not withhold the 20 percent on the company stock.

The problem with not knowing what you have to know until you need to know it is that tax laws are unforgiving. If you find out about NUA after the rollover distribution is done, IRA rules apply. IRA rules do not recognize a difference between company stock and any other asset.

It’s never enough, however, to know the rules—it’s how to apply them that matters in the end. This could be a great tax break for you and a lousy one for your neighbor.

Charlotte found out (almost the hard way) that because she didn’t specialize in transferring company retirement plans, like we do, she would have never known about NUA, causing her to give $128,284 to the IRS. Thankfully, we were able to help her avoid all this. We figure this one move alone will pay for our services forever.

Charlotte & her husband bought an RV/Motor home with the $128,284 in extra tax savings we were able to find for them, and are traveling all over the US 6 months out of every year. Something they’d always dreamed about, but never thought they’d ever be able to do!

What About You?

Do you have a Financial Road Map and written Action Plan to give you the best chance of having (and keeping) a “Worry-Free Retirement”, so you’ll never run out of money, no matter how long you live, and never be a burden on anyone?

That’s what we’re here for. We create Financial Road Maps and written Action Plans for retirees and people planning to retire within the next 5 years—to give you the best possible chance of having a “Worry-Free Retirement.”