New Report Concludes Electing Net Unrealized Appreciation Tax Treatment May Be the Best
Strategy to Maximize Value of Company Stock in 401(k) Plans for Many Retirees

BOSTON, May 17, 2007 -- Millions of Americans may be able to lower their tax bills and keep more retirement assets by electing a special tax treatment, net unrealized appreciation (NUA), for the sale of appreciated company stock in their workplace savings plans. This is one of the conclusions of a new report by the Fidelity Research Institute.

"We believe this is one of the most financially valuable, but little known strategies in retirement planning today," said the Institute's executive director, Guy L. Patton. "We're hoping to help Americans understand and take advantage of an opportunity that can significantly lower their taxes and increase the assets available to them in retirement."

The report, "Maximizing the Value of Company Stock at Retirement," examines the tax saving opportunities and implications of electing NUA treatment of company stock as a strategy to help increase the value of retirement investments.

NUA is the appreciation of company stock purchased and held in a qualified plan, such as a 401(k) plan or an employee stock ownership plan (ESOP), above the initial purchase price (referred to as cost basis). For example, if an employee purchases 100 shares of company stock for $20 per share in his/her 401(k) plan, and five years later the shares are worth $35 each, then the current value of those shares, $3,500, would break down into $2,000 of cost basis and $1,500 of NUA.

The Institute estimates that more than 24 million Americans today hold approximately $400 billion in company stock in their workplace savings plans. This includes 2.5 million people within 55-64 years of age, who have as much as $40 billion in stock appreciation.

"There is significant wealth in play here and we estimate that 60 percent of pre-retirees with workplace savings plans would benefit from evaluating the impact of NUA treatment," said Patton. "Once people understand the benefits of electing NUA, we believe they'll act to protect more of their retirement assets by minimizing an unnecessarily large tax bill."

Unknown by many individuals, the Internal Revenue Code provides special tax advantages on the distribution of company stock with NUA. It allows an individual who is retiring or changing jobs to take a distribution of company stock and immediately pay ordinary income taxes on just the basis of the stockⁱ and not the appreciated value. One of several conditions that need to be met, which can disqualify NUA treatment for many retirees, is the need to take a lump-sum distribution from the plan.

In all cases, the NUA is not taxed until the company stock is sold outright. When that event occurs, either immediately or at a later time, the NUA is taxed at the then-applicable long-term capital gains tax rate and not at the higher ordinary income tax rate. With the current maximum ordinary income tax rate at 35% and the current maximum capital gains tax rate at 15%, the potential tax savings are substantial.

The Institute report provides a hypothetical example for a 50-year-old executive who has $100,000 in company stock ($80,000 in NUA and $20,000 in cost basis) in her defined contribution plan at time of retirement. The example shows the financial impact of electing NUA versus rolling over to an IRA. Assuming a federal tax rate of 35%, a capital gains rate of 15% and a 10% early withdrawal penalty, the executive would save $24,000 by electing NUA tax treatment.

"Understanding the rules governing NUA transactions presents certain complexities for retirees, but when implemented correctly, NUA election for company stock holdings can result in significant financial benefit for the retiree," said Patton.

Understanding the Four Options for Disposition of Company Stock at Retirement

The report outlines four basic options and results for handling company stock at retirement. Additionally, the Institute uses a hypothetical example of a 65-year-old employee retiring with $100,000 in company stock, which is assumed to be 25% more volatile than a diversified equity portfolio, to highlight the implications of choosing the different options.

•		Option 1: Take a distribution of the entire workplace retirement plan, elect NUA treatment for company stock and rollover remaining assets into an IRA -- then hold the company stock in a taxable account until the assets are needed at a later date, perhaps even leaving the stock to heirs.
•		Option 2: Take a distribution of the entire plan, elect NUA treatment for company stock and rollover remaining assets into an IRA -- then immediately sell the company stock in the taxable account and reinvest the proceeds in a diversified equity portfolio, or any other desired set of investments.
•		Option 3: Take a distribution of the entire plan, including company stock, and rollover into an IRA -- then immediately sell the company stock and reinvest the proceeds in a diversified equity portfolio.
•		Option 4: Keep company stock in the qualified plan.

The Institute analysis reveals that for short holding periods (5 years or less), option 2 generally provides the highest net after-tax liquidation value, while for longer holding periods (15 years or more), option 3 generally provides the highest net after-tax liquidation value. The higher the NUA as a percentage of market value, the greater the benefit from distributing company stock to a taxable account.

The report concludes that in a majority of cases, the best strategy for individuals is to sell their company stock after retirement, whether it is distributed to a taxable account or rolled over to an IRA. Additionally, not only does the amount of time one plans to hold the company stock determine whether an investor should elect NUA, but the volatility of that company stock, the amount of appreciation and the NUA to market-value ratio all contribute to determining the best course of action. In general, the larger the amount of NUA to current market value, the more advantageous it is to elect NUA tax treatment.

About the Fidelity Research Institute

The Fidelity Research Institute is designed to advance knowledge of how proven investment theory and public policy can be put into practice to help Americans invest wisely to meet their financial needs. The Institute works with resources across Fidelity Investments as well as within the financial services industry and academia to accomplish its mission. Its reports are available at www.fidelityresearchinstitute.com.

iAssuming the stock was purchased with pre-tax dollars; basis here is a special kind of basis that only applies to the NUA of company stock.

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