Money Talks: IRA Rollovers - The Best Strategy?

Reprinted from PN January 2001

If you're retiring or changing jobs, you may have heard that rolling over your retirement-plan assets, such as those you might have in a 401(k) plan, into an Individual Retirement Account (IRA) is the way to go. The assets can then continue to grow tax-deferred until you begin withdrawing them in retirement.

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But an IRA rollover might not be the best solution for all your retirement-plan assets. A special tax treatment can make it more advantageous for you to deposit the employer securities held in your employer's plan into a taxable account. (Generally, employer securities include stock, marketable obligations, or certain publicly traded partnership interests issued by a parent or subsidiary corporation.)

Special Tax Treatments

Retirement-plan distributions that are not rolled over into an IRA generally are taxed as ordinary income based on the fair market value of the assets at the time of distribution. Depending on your federal income-tax bracket, you could be taxed at a rate of up to 39.6% and be liable for state taxes.

However, when you take employer securities as part of a lump-sum distribution, you can elect to pay ordinary-income taxes on the average cost basis of the securities (the average value of the shares at the time they were acquired within the plan) rather than the current market value. The difference between the securities' cost basis and the market value upon distribution—the net unrealized appreciation (NUA)—is not taxed at the time of the distribution from the employer's plan.

After the securities are distributed to you, taxes can continue to be deferred on all of the appreciation on the securities held in your taxable account, until the shares are sold. Even then, taxation on the NUA is at the long-term capital gains rate of 20%, which could be significantly lower than your ordinary-income tax rate.

For example, suppose your account contains employer stock costing an average of $10 a share. You have held it for a number of years, and it is now worth $50 a share. If you deposit the shares into a taxable account, at the time of distribution you are taxed on the average cost of $10 a share. When you sell the shares later, you will pay taxes on the remaining $40 a share at your long-term capital gains rate, which generally is 20%. Any appreciation of the stock after it has left the plan will be taxed as long- or short-term capital gain, depending on how long the stock was held after its distribution.

Estate-planning Issues

As a further incentive to not roll over employer securities, tax laws allow a special benefit for your heirs. If you leave your employer securities to your heirs, they will still pay long-term capital gains taxes on the NUA when they sell the shares. However, your heirs receive the employer securities with a "stepped-up basis"—their new cost basis would equal the value of the securities on the date of death minus the NUA.

In other words, your heirs never have to pay taxes on the amount of appreciation from the time of distribution to the time of your death. If you roll over the shares into an IRA, your heirs won't get this tax benefit. Generally, distributions from an IRA to a beneficiary are fully taxable at ordinary-income tax rates.

For example, if the share price of the employee stock mentioned in the earlier example reached $100 a share when it was transferred to your heirs, the new basis is considered $60 a share—the value of the shares at death minus NUA of $40 a share. There will never be any tax due on the increase in price from $50 to $100 a share.

Consult a legal or tax advisor about how this special tax treatment may affect your estate plan.

Factors to Consider

If your intent is to hold your employer securities after you take the distribution, depositing them in a nonretirement account may be an option. Before deciding to do this, however, consider a few factors.

First, you need to be able to pay the taxes immediately due on the shares. Even though the shares are taxed at cost basis, you may be looking at a sizable tax liability, depending on the value of your employer securities.

In addition, if you are separated from service before age 55, or are under age 59-1/2, you could be liable for a 10% tax penalty. The assets not rolled over into the IRA are considered an early withdrawal from a retirement plan, unless an exception applies.

You should also consider any tax liability created by holding the shares. Dividends paid on the employer securities in the taxable account will be taxed as ordinary income.

Aside from issues of taxation, which you should discuss with your tax advisor, you must consider whether holding your employer securities meshes with your overall investment strategies. The amount of employer securities you retain should be prudent in terms of your portfolio's diversification and its volatility. If you decide that continuing to hold as much employer securities as you currently do carries too much investment risk but you would like some opportunity for further gains, you can always sell some of the shares, either from a retirement account or a brokerage account, and retain the rest in your taxable account.


If you are retiring or changing jobs, you have several alternatives for taking a distribution from an employer-sponsored retirement plan. How to handle a distribution that includes employer securities is just one of many decisions you must make. Your financial consultant can help you analyze the impact of each strategy on the value of your retirement assets.

Note: Because Merrill Lynch does not provide legal or tax advice, speak with a legal or tax advisor before taking any action.

Rosemary Berkery is senior vice president and director of the Merrill Lynch Private Marketing Group. Visit the company's Families of Children With Disabilities Program Web site, Contact: David Cleary, financial consultant, Merrill Lynch Private Client Group, (800) 937-0405 / (949) 859-2932 /


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Money Talks: IRA Rollovers - The Best Strategy?


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