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Company Stock in Your 401(k) Plan: Keep It Balanced!

By Brenda Watson Newmann
401k Forum Senior Editor



Does your 401(k) plan give you the choice of investing in the company you work for? While this may sound like a great idea, you should keep a few points in mind when deciding how much of your retirement future you should stake on one company.

There are different ways your plan might offer company stock. One of your investment options might be a stock fund of your employer's stock - meaning you can choose whether or not to invest in it. Or, your employer may always make matching contributions in stock rather than cash, meaning you don't have a choice.

According to a study by the Employee Benefit Research Institute, 401(k) participants who get their employer match as company stock have over half their total account balances invested in company stock.

In plans that offer a company stock fund as an investment option, but where the employer doesn't match with company stock, on average just under 20% of total account balances are in company stock.

It is difficult to give a hard-and-fast rule as to how much company stock you should own in your 401(k). Some experts say it should be no more than 10-15%. But the answer may depend on many factors, including how solid your company is, what kind of future it has, whether you have other investments, and how diversified those other investments are.

Tax Advantages for Employer and Employee

Employers offer company stock in a 401(k) plan for several reasons. Some believe that making employees part-owners of the company will give them incentive to work harder to make the company succeed, and a greater feeling of satisfaction when it does. Also, when employers use company stock to make matching contributions it is less expensive for them than using cash, for tax reasons.

There might also be tax advantages for you, the employee, if you withdraw the company stock when you retire rather than rolling it over into an IRA. But this can be tricky to calculate so it's a good idea to consult with a tax professional on your specific situation.

Here's why. When you retire, if you take a distribution of your company stock, you will pay income tax on the cost basis of the stock - that is, what it was worth when you acquired it, not what it is worth when you withdraw it.

Say you have 1,000 shares at a cost basis of $15. When you withdraw it, the market price is $40 a share. You will pay tax on $15,000 rather than $40,000. If you sell the stock, you will pay capital gains tax on the difference between the cost basis and the sales price.

Now, say that you rolled those shares into an IRA instead of withdrawing them. You wouldn't pay any tax when you made the rollover. However, when you sold the stock you would have to pay income tax on the full value of the stock. Keep in mind that capital gains tax, at 20%, is probably going to be lower than your income tax.

If you roll the stock into an IRA, you don't pay tax right away so you'll have use of that (tax) money for a longer time. If you don't plan on selling the stock soon (at which point you'll have to pay tax), this could be an advantage. On the other hand, if you don't roll the stock into an IRA you may also have an advantage if you hold the stock for a longer time, if it continues to appreciate, because you benefit from the lower capital gains tax on the appreciation.

Yes, it is complicated. We warned you!

Inheritance advantages

If you take the stock out of your 401(k) and don't roll it over into an IRA, there's an even bigger break in store for your heirs, if you don't sell your company stock during your lifetime. Your heirs will receive the stock at its current value when they inherit it. If they sell it, they will only pay capital gains on the difference between the current value when they received it, and the price they sell it for. In other words, the gain from the time you took the stock out of your 401(k) until the time your heirs sell the stock is never taxed.

Diversify, Diversify!

Keep in mind, too, that you shouldn't put all your retirement eggs in one basket. If your retirement account is dependent on stock in a company that goes through a rough patch, or goes bankrupt, you could find yourself in financial difficulty.

If you have the option of investing in a company stock fund in your 401(k), you should also remember that it is not a diversified investment like a typical mutual fund, which would invest in a number of different companies.

Also, it is interesting to note that in "defined benefit" pension plans, which are run for companies by financial experts, by law no more than 10% of the money may be invested in company stock. In fact, some pension professionals have asked why there are not similar limits for individuals when choosing their 401(k) investments.

It makes good sense to hold a variety of different investments in your retirement account, so that if one does poorly others will counterbalance it.

When deciding what you should do, keep in mind that the future is unpredictable, and you don't know how your company will fare down the line. If your company's stock price falls, you stand to lose a good chunk of your retirement money. If your company goes bankrupt, you'll not only lose your job, but a good chunk of your retirement money as well.


The information provided here is intended to help you understand the general issue and does not constitute any tax, investment or legal advice. Consult your financial, tax or legal advisor regarding your own unique situation and your company's benefits representative for rules specific to your plan.
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