What’s the most hazardous holding you could have in your 401(k) plan? The answer: your employer’s stock. No matter how much you love the company you work for, having too much of its stock in your retirement plan is a risk that’s rarely worth taking.
How much is too much? Most financial planners will tell you that company stock should represent no more than 20 percent of your holdings. Lee Rosenberg, CFP professional and president of American Investment Planners in Jericho, New York, says he’s more comfortable with a 10 percent max. As he notes, most large, well-managed mutual funds rarely have more than 2 to 5 percent in any single stock.
What’s more, investing in the company you work for can be doubly dangerous. If your employer falls on hard times, you might not only lose money in your retirement plan — you could lose your job, too.
The classic case is Enron Corp. In 2001, shares in the high-flying energy company plummeted from more than $80 to under $1. Thousands of former Enron employees, suddenly jobless, looked on in horror as their 401(k) plans lost more than $1 billion collectively. Enron may be an especially dramatic example, but it wasn’t the first and, unfortunately, probably won’t be the last.
There are instances when you might want to ignore the usual advice on company stock, if you’re willing to accept the risks.
1. If you think your company could be the next Apple or Facebook. Loading up on company stock could make you very wealthy someday if your company is poised for spectacular growth. Before you buy into that magical scenario, of course, you’ll need to analyze the company’s prospects dispassionately and continue to pay close attention for as long as you hold the stock, Rosenberg points out.
Even then, it’s impossible to know for certain. Enron looked like a winner at one time, too.
2. If you want to take advantage of a special tax break. Company stock is treated differently from other types of assets in a 401(k) plan when you withdraw it. If the entire account is distributed to you as a lump sum when you retire or change jobs, you can elect to have your company stock put into a taxable brokerage account and your other retirement assets rolled over into a tax-deferred IRA.
At that point, you’ll pay income tax only on what the stock was worth when you first got it, not on its current price. The difference in value, called “net unrealized appreciation,” isn’t taxed for as long as you keep the shares. When you do sell, it will be taxed as a long-term capital gain rather than as income, which could mean a much lower tax bill. The IRS explains the rules on its website.
Whether this tactic makes sense for you will depend on a number of factors, including your age, how much stock you own and how close you are to retirement. Consulting a knowledgeable tax pro would be money well spent.