Planning Strategies for Large 401(k)s

November 03, 2003

By Dave Polstra, CPA, CFP®, CIMA® 

When executives acquire large positions in their company's stock through long-term participation in their 401(k) plan. In fact, for someone who has worked at a company for thtirty or forty years it is not unusual to see account balances in the millions. When large concentrations of stock are inside a qualified plan, it usually means that these shares were bought at a low price and have appreciated significantly over the years. In technical terms, this is called Net Unrealized Appreciated ("NUA"), and in the right situation NUA can lead to some creative planning opportunities. The example below illustrates how an executive might take advantage of NUA inside their 401(k).

Joe Smith retires from the XXX Corporation in 2003. He has a 401(k) plan worth $1 million, as well as significant other investment assets. He and his wife, both age 60, are very involved in several charities in their community and want to volunteer their time and make some gifts to help these causes financially. They implement a technique called the "NUA/CRT rollover." Here's how it works. Let's assume that Joe's 401(k) consists exclusively of shares of company stock. Also assume that Joe paid only $100,000 for these shares over the years — in other words, the shares have net unrealized appreciation of $900,000. Joe requests and in-kind distribution of his 401(k) account, i.e. he receives a stock certificate for his shares inside the plan. When Joe receives his certificate, he will also receive a statement describing the tax implications of his distribution. In this case, his taxable amount will only be $100,00 due to a special benefit allowed by the tax code. Once Joe receives his shares, he then transfers them to a special trust called a Charitable Remainder Trust. He and his wife receive a charitable income tax deduction of approximately $285,000 for transferring these shares to the trust. The shares are sold and reinvested for diversification purposes without incurring any income taxes (the trust is a tax-exempt trust).

For the rest of their lives, Joe and his wife receive a check equal to 5% of the value of their trust. Then, after their death, selected charities receive the balance of the trust. Joe has gotten his 401(k) plans distributed virtually income taz free, he's created a lifetime income stream of approximately $50,000 per year for he and his wife, and they've benefited several charities in the process — a win, win, win situation!