How to Exit Your 401(k) Plan

By Daniel Kadlec

If you've built a large 401(k) portfolio with the help of an employer kicking in shares, your biggest concern as you prepare to start taking money out may be what to do with all that company stock. The average 401(k) participant who gets a matching contribution in company shares has 55% of 401(k) assets in the stock of his or her employer, according to a recent study by the Investment Company Institute. Even those who do not get a matching contribution in company stock tend to have a lot of the stuff, having directed their own contributions that way for years.

Step 1: diversify. This is no time to have a lot of eggs in one basket. Generally you are free to reallocate stock bought with your contributions. If you've got 20% of your assets in your employer's stock, shift a portion into diversified stock mutual funds or, to get conservative, intermediate-term bond funds or guaranteed-income contracts. Stock your employer kicked in generally can't be touched. But some plans will let you reallocate those shares after you've been with the company a specified length of time or have reached age 55.

Once you're retired, consider taking your employer's stock out of your 401(k) plan--not as cash but "in kind," physically getting the shares. It can lower your tax bill dramatically, and for anyone with a low cost basis, "it's definitely a go," says BankBoston 401(k) expert Marvin Rotenberg.

Company shares worth hundreds of thousands of dollars in your plan may have cost only tens of thousands to buy. When you take a cash distribution, the stock is sold at market value, and you pay ordinary income tax on the full distribution. But when you take stock, not money, you pay ordinary income tax only on the cost basis, then capital-gains tax on the appreciated value when you sell. In many cases the capital-gains rate is half the combined federal, state and local income-tax rate. The strategy also lowers your 401(k) balance, which lowers your mandatory distributions at age 70 1/2 and gives you cash to gift to reduce your estate.

--By Daniel Kadlec