A common planning strategy when one has left a company with a large stock position with a low cost basis is to employ Net Unrealized Appreciation (NUA).  This strategy allows for the transfer of the stock from a 401k to a taxable account with the basis in the stock taxed at ordinary income rates and the gain, the net unrealized appreciation, taxed at capital gain rates once the stock is sold.  If you are under 55, you will need to consider the impact of the 10% early withdrawal penalty on the cost basis of the stock.  The additional benefit in this strategy is the flexibility gained in the ability to liquidate the stock position overtime at the beneficial capital gain rates.

However, now according to IRS notice 2009-75 you have an additional choice to consider within the NUA strategy as you can now move the company stock to a Roth IRA.  In this case, the cost basis will be taxed at ordinary income rates, but the Net Unrealized Appreciation will be taxed at capital gain rates at the time of distribution, not when sold as in the above example.  Distributions from these accounts then would be tax free because you already paid ordinary income on the basis and capital gains on the net unrealized appreciation.

Does a Roth NUA strategy make sense?   As a practical matter, probably not.   Many who use the NUA strategy are attracted to the idea of moving money from “tied” up resource to one that allows for more flexibility at a reasonable tax hit.  Nevertheless, the argument can be made that if you have a longer time horizon, or are thinking about the move to a Roth as an estate planning strategy, then the Roth NUA strategy would be something to consider

While much of the talk of Roth conversions have to do with analyzing the benefit for the current holder of the IRA asset, there is another aspect to consider that has to do with your overall Estate plan.  

In fact, If you are in a position where you do not need to distribute money from a IRA for living expenses, then convesion to a Roth IRA can makes sense from an estate planning perspective.  By paying the tax now, you will remove some cash from your estate that would be possibly be subject to a higher estate tax.  And finally, and most importantly,  you can transfer the asset to your children and your children will have an non taxable asset.  They will need to take the tax free distributions over their life expectancy.

Before you convert to a Roth, there are few guidelines that are important.

The first is  funds need to be available outside the IRA before you convert to pay for the tax.   Otherwise, if you pay taxes with the money from the conversion, you will be levied a 10% early withdrawal penalty if you are under 59 1/2.   The second guideline  is to  know the effect the conversion will have on your tax bracket.   The amount converted is treated as ordinary income and can easily push you up to a higher bracket.   The other consideration is your expectation of your tax bracket in the future.  The general rule is if you think you will be at a similiar or higher tax bracket in the future then it makes sense to seriously consider a conversion.

Let’s say you decide that the Roth conversion was a mistake, what can you do? 

 You can reverse the Roth conversion decision through recharacterization of the conversion.  By doing this,  the Roth conversion never happened.  You have until your tax filing deadline the year following the conversion to recharacterize the Roth conversion. 

Why would this happen?  Well, for one, the market sells off 30%  from when you converted  and consequently you ended up paying taxes on a higher amount than the current value.  You can then recharacterize , then reconvert at the lower value.