Does your 401k 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, 401k 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 401k. 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
401k 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 401k 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 401k 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 401k, 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 401k 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.
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