Distribution of Employer Securities from a Qualified Retirement Plan

Terrace SunsetMost individuals are aware that retirement-plan benefits fare poorly under the tax code: They are subject to ordinary-income tax on distributions during the life of the owner and surviving beneficiaries as well as estate tax, if applicable, at death. In some instances the combined tax can reach more than 70% when state death taxes are factored in!

To avoid immediate taxation upon retirement or separation from service, many employees elect to roll over their benefits to an IRA. There are several advantages to doing so: avoiding income tax on the retirement benefits; having the benefits continue to grow on a tax-free basis; enabling the employee to sell securities in the IRA and diversify the portfolio without incurring income tax; and stretching the distributions from the IRA once age 70½ is reached, according to a very favorable life-expectancy schedule.

Many qualified retirement plans—and more specifically for purposes of this article, 401(k) plans—invest a portion of the contributions made on behalf of employee participants in the securities, both stocks and bonds, of the sponsoring employer. The extent of investments in employer stock varies. Prior to the Enron debacle it was quite extensive, and in many instances employees did not have much choice in the matter. Recent legislation now enables employees a much wider choice of investments, including the option of opting out of owning any employer stock. Nevertheless, substantial amounts of employer stock still reside in 401(k) plans.

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