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401(k) plan non-spouse beneficiaries get a tax break
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Company stock in the 401(k)
If a 401(k) plan contains employer stock, beneficiaries can take advantage of a tax break known as "Net Unrealized Appreciation," or NUA, which enables them to pay tax just on the cost of the shares. This provision was in place before the new pension law was passed, and it has applied to both account holders and their beneficiaries. But to maximize the tax break, this is one time when you want to move the stock into a taxable brokerage account rather than a tax-deferred account.

To qualify for the tax break, the entire plan balance would have to be emptied in one year.

"In the past, a beneficiary would have had to take out everything, and the noncompany stock assets would have been taxable immediately," says Slott. "Now the noncompany stock assets can be transferred to a properly titled inherited IRA, and the stock can be put in a brokerage account.

"You don't sell the shares in the plan," says Slott. "If you do, you blow the tax break." Instead, the stock shares are transferred as stock in kind. Then you pay tax only on the cost of the shares, and you don't pay any more tax until the stock shares are sold.

So, for example, let's say a beneficiary inherits a 401(k) plan worth $1.5 million from a parent. Half of it is in company stock shares. The assets that are not company stock go into a properly titled inherited IRA via a trustee-to-trustee transfer. The company stock shares get transferred in kind into a brokerage account. Let's say the cost of the shares was $75,000. The beneficiary pays ordinary income tax on the $75,000 and doesn't pay any more tax until the shares are sold. At that point, only long-term capital gains rates apply, currently a maximum of 15 percent. The shares get long-term gains treatment the day after the transfer -- you don't have to wait a year.

Nothing in life is easy -- not even inheriting 401(k) money. That's why it's important not only for you to understand it, but also for you to impart the information to your nonspousal beneficiaries so that they can take advantage of these tax breaks. Because once you're dead, there's really no turning back.

Longtime financial journalist Barbara Mlotek Whelehan earned a certificate of specialization in financial planning. If you have a comment or suggestion about this column, write to Boomer Bucks.'s corrections policy -- Posted: Sept. 27, 2006
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