North County San Diego
What do I do with my company stock when I retire?
The default paperwork at retirement quietly gives up an election that can be worth six figures. It cannot be undone.
The default paperwork at retirement quietly gives up an election that can be worth six figures. It cannot be undone.
If your employer's stock sits inside your 401(k), there is a one time election that can tax decades of growth at capital gains rates instead of ordinary income rates. It is available only when the shares leave the plan as actual shares, and it is destroyed the moment you roll that account into an IRA.
The paperwork handed to most people at retirement does exactly that. Roll everything to an IRA, which is the right answer for almost every other asset and the wrong one for this.
Whether it is worth using depends on how much of the position is growth rather than what was originally paid for it. If the stock has multiplied several times over, it is frequently the largest single tax decision of the whole retirement.
The shares in your plan have a cost, which is what was paid for them over the years, and a value, which is what they are worth now. The difference between the two is the growth, and tax law has a name for it: net unrealized appreciation.
Take the whole account as cash or roll it to an IRA and that distinction disappears. Every dollar becomes ordinary income when it eventually comes out, taxed at the same rate as a salary.
Take the shares out as shares and the two parts are taxed separately.
In the year of the distribution, as ordinary income. This is the price of using the election.
Only when you actually sell the shares, and then as long term capital gain.
Even if the shares were bought last year. The holding period is not computed on that portion.
Suppose the plan paid $120,000 for shares now worth $900,000. The growth is $780,000.
Rolled to an IRA, that $780,000 comes out over your retirement as ordinary income. For a couple whose other income already fills the lower brackets, much of it lands at 22% or 24%, and the top of it can reach higher.
Using the election, you pay ordinary income tax on $120,000 in the year you do it, and the $780,000 is taxed as long term capital gain whenever you choose to sell. For a married couple in 2026 the capital gains rate is zero up to $98,900 of taxable income and 15% up to $613,700.
The election requires what the law calls a lump sum distribution, which is a precise term rather than a general description.
Not part of it. The whole account has to come out.
All of it, in a single calendar year. Spreading it across a year end breaks it.
Leaving the employer, reaching 59 and a half, death, or disability.
All plans of the same kind at the same employer are treated as one plan for this test. If you have a 401(k) and also a legacy profit sharing account from the same company, both have to be emptied in the same tax year. Dealing with one and leaving the other for January defeats the whole thing.
Internal Revenue Code section 402(e)(4)(D). Amounts payable to a former spouse under a court order are excluded from the balance.
The practical advice is simple even though the rule is not: do not take anything out of the plan, in any amount, until the whole sequence has been planned. The cost of an accidental withdrawal in the wrong year is the entire benefit.
If you are under 59 and a half, the extra 10% applies only to the amount actually included in your income, which is the cost, not the market value of the shares. On the example above that is 10% of $120,000, not of $900,000.
And if you left the employer in or after the year you turned 55, the extra tax does not apply at all. That exception exists for workplace plans and is lost the moment the money moves to an IRA, which is a second reason the default rollover can be expensive.
The surtax that applies to investment income for higher earners does not reach the appreciation that came out of the plan. The regulations treat it as a plan distribution, which is excluded. Only the growth after the shares left the plan, and dividends received afterwards, are caught.
Most comparisons add 3.8% to the capital gains side and conclude the election is worth less than it is.
You will read that holding the shares until death wipes out the tax. You will also read that these shares get no step up at all. Both are wrong.
The appreciation that came out of the plan is treated as income your heirs receive in your place, and it never steps up. The growth after the distribution does step up. So an heir's basis is the value at death minus the original appreciation. Holding forever is not the escape hatch it is usually presented as.
Revenue Ruling 75-125. Where federal estate tax was paid on that amount, a deduction may be available to the person receiving it.
The election is not free. You pay ordinary income tax on the cost in a single year, up front, and that money leaves your retirement account for good.
There is one more consideration that has nothing to do with tax, and for many people it should come first.
If a large share of your retirement sits in one company's stock, you are exposed twice over, and the exposure is correlated. FINRA puts it directly: company stock carries the risk that your employer's financial problems become your financial problems.
For someone already retired the job risk is behind them, but the concentration is not. A single company can fall by half for reasons that have nothing to do with the wider market, and a retirement drawing down from that position has no time to wait for a recovery.
FINRA declines to set a rule, but cites an expert guideline of no more than ten percent of total investment assets in a single stock, adding that the figure could be too high depending on circumstances. It also warns about hidden overlap, since index funds a retiree already owns may hold the same company.
The Department of Labor separately notes that participants in these plans generally have the right to divest publicly traded employer stock and move it into other options.
None of that means sell everything on day one. It means the tax question and the risk question are different questions, and the tax answer should not be allowed to decide the risk answer by default. Selling down over several years, using the capital gains brackets deliberately, is frequently the resolution.
California follows the federal treatment, so the structure works the same way. What California does not do is tax capital gains at a lower rate. The Franchise Tax Board states plainly that all capital gains are taxed as ordinary income.
The federal saving is real and often large. The California saving on the same transaction is nil, because that state taxes the gain at the same rate either way. Any comparison that applies a blended rate without separating the two will overstate the benefit for a California resident.
One point in the other direction: California's additional tax on early distributions is 2.5%, not 10%, and like the federal version it applies only to the amount included in income.
If you were going to give to charity anyway, appreciated shares held more than a year are generally deductible at their full market value, and the gain is never realised. Selling first and donating the proceeds gives up both advantages.
The deduction for appreciated securities is limited to 30% of your income in a year, with five years to carry forward anything above that.
Beginning in 2026, an itemiser can only deduct charitable contributions above half a percent of adjusted gross income. Amounts below that floor are not deductible. Any giving plan built on guidance written before mid 2025 needs rechecking against this.
If charitable giving is already part of the picture, the shares with the lowest cost and the largest gain are the ones to give, and this is one of the few decisions where the tax answer and the risk answer point the same way.
Almost every way this goes wrong is a sequencing error rather than a judgement error.
Your plan administrator holds it. Without that number nobody can tell you whether the election is worth using, and the answer genuinely differs from person to person.
Any distribution before the plan is settled risks the one tax year requirement. The safe position is to touch nothing.
Old profit sharing accounts and plans from acquired companies are the ones people forget.
Paying it by selling the shares you just distributed undoes much of the benefit.
If you are also deciding what to do with the rest of the account, we worked through the four options and what each one costs in What do I do with my 401(k) when I retire?
The line only matters against your own figures. Our planning tool projects your income year by year, so you can see which years sit under it, which do not, and what it costs either way.
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Find out what the plan paid for the shares before you move anything. If the growth is large relative to that cost, there is an election that taxes the cost as ordinary income now and the growth as long term capital gain when you sell, which is frequently worth a great deal. Rolling the account into an IRA gives that up permanently, and the standard retirement paperwork usually does exactly that.
It is the difference between what your retirement plan paid for your employer's shares and what they are worth when they leave the plan. If the shares are distributed as shares rather than rolled over, only the cost is taxed as ordinary income at that point. The appreciation is taxed as long term capital gain when you eventually sell, and it is treated as long term regardless of how long the shares were actually held.
For any shares that go into the IRA, yes. Once inside an IRA, everything that comes out is ordinary income and there is no mechanism that preserves the capital gain character. This is why the decision has to be made before the rollover paperwork is signed, not afterwards.
Only on the amount actually included in your income, which is the plan's cost in the shares, not their market value. If you separated from the employer in or after the year you turned 55, the additional tax does not apply at all. That exception belongs to workplace plans and is lost once the money is in an IRA.
No. The regulations treat the appreciation that came out of the plan as a plan distribution, which is excluded from net investment income. Only the growth after the shares left the plan, and dividends received after that point, are subject to it. Comparisons that add 3.8% to the capital gains side understate the value of the election.
Partly. The appreciation that came out of the plan is treated as income in respect of a decedent and does not step up. Growth after the distribution does. An heir's basis is therefore the value at death less that original appreciation, so holding the shares until death does not erase the tax the way it would for ordinary investments.
California follows the federal rules, so the structure works the same way. However California taxes all capital gains as ordinary income, so there is no state rate advantage on the appreciation. The benefit is federal only, which matters when comparing options as a California resident.
FINRA does not set a rule but cites an expert guideline of no more than ten percent of total investment assets in any single stock, noting it could be too high depending on circumstances. It also warns that index funds you already own may hold the same company, which hides the true concentration. The tax decision and the risk decision are separate, and selling down gradually across several years is often how both get resolved.