Employers do what they can to foster a sense of ownership in their employees. After all, if you stand to benefit from a company’s success, you’re more likely to do a great job for them, or so the logic goes.
So, when you are hired for a job or promoted within your existing company, you might be offered some sort of ownership benefit. You might even get to decide whether to take all of your pay in cash or to use some of your pay to purchase equity in the company.
At first glance, the answer might seem simple: Show me the money! However, there are situations in which an equity position may make more financial sense. Finding that line is key to getting the most compensation from your career.
What do you need to know, then, to ask the right questions?
In some cases, employees have the choice to buy company stock in a tax-deferred retirement plan sponsored by their employer, the most common of which is the 401(k). In other instances, there may be other ways to buy into ownership.
Why is a retirement plan choice important? Well, the point of these retirement accounts is that you’re not paying tax on money today but rather at some point in the future when you take a distribution. If you are taking a distribution from the sale of stocks in your 401(k), you may have the choice of treating the appreciated securities as ordinary income or using the net unrealized appreciation (NUA) tax treatment.
It's critical to point out that the NUA choice only works when you buy stocks that are kept in your workplace retirement account. The NUA election isn’t available for other types of accounts.
With an NUA, when you take this type of in-kind distribution (payment in the form of securities rather than cash), the rules are complex. So keep in mind that this article is providing a high-level overview and is not a replacement for real-life advice regarding assets held in your retirement account. You should consult a tax professional with an understanding of distribution rules before modifying or adjusting a distribution strategy.
There are several benefits to using an NUA with a distribution. For example, when securities are sold, any NUA is taxed at a long-term capital gains rate, which may be lower than an ordinary income tax rate. So, an NUA approach may help you manage your tax bill.1
However, there are limitations, too. The NUA decision must be weighed against the potential market risk of holding a single stock upon distribution.1
Once you reach age 73, you must begin taking required minimum distributions (RMD s) from your 401(k) or any other defined contribution plans in most circumstances. Withdrawals from your 401(k) or any other defined contribution plans are taxed as ordinary income and, if taken before age 59½, may be subject to a 10 percent federal income tax penalty.
Each of these scenarios might feel complicated, or even confusing, but there’s good news. You have a financial professional in your corner who may be able to offer insights into your overall compensation strategy. Their assistance may be key in helping you make decisions about whether to add equity to your retirement assets.
1. Ameriprise.com, 2023.