Quick-quiz question: Is there ever a time when a client can pay capital gains tax rates on a distribution from a qualified retirement plan?

Answer: Yes, there is. This opportunity occurs when the client holds employer stock in the plan. The Net Unrealized Appreciation (NUA) in the stock can qualify for favorable long-term capital gains tax treatment, rather than ordinary income treatment, after a distribution is taken–but only if four IRS requirements are met:

  1. The distribution must occur at a triggering event, such as retirement or separation from service.
  2. The company stock must have been acquired with pre-tax employee contributions or employer matching contributions.
  3. The full vested balance in all employer plans must be distributed in a lump-sum–i.e., in the same tax year.
  4. The employer stock must be distributed to a non-retirement plan account. (Other plan assets can be transferred to an IRA.)

If all four requirements are met, income tax on the NUA will not be due until the stock is sold.

At the plan distribution event, the investor's cost basis in the stock is taxed as ordinary income.

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