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Losses in 401(k)s Usually Aren't Tax-Deductible

If I lose money in my 401(k) plan, could I claim that as a loss on my 2008 tax return? How would I do that? What is the maximum I could claim, and what would I need to prove it?

Rowena Bill
Pittsburg, Calif.

The short answer is no, according to Kyle Brown, a retirement-plan attorney with Watson Wyatt Worldwide in Arlington, Va.

"In your regular brokerage account, if you hold stock that has lost value, you can sell it and use the loss to offset capital gains, or you can carry the loss forward," Mr. Brown says. But 401(k)s and other qualified retirement plans are tax-deferred. "So just like when you sell stock in your 401(k) for a gain, and you don't have to pay tax on the gain, you also don't get to recognize the loss."

The only time you are taxed is when you take a distribution from the 401(k) -- and at that point, you pay ordinary income tax, Mr. Brown says.

Let's say that you contributed $100,000 to your 401(k) over the course of your career. Now, you take a lump-sum distribution of the entire balance, and the value has fallen to $75,000. "That's not a deductible loss," Mr. Brown says. "You weren't taxed on that money when it went in. You are taxed on the amount you pull out."

One way in which you might be able to recognize a loss on your 401(k) account involves a tax break called net unrealized appreciation. This allows you to withdraw your company stock from your 401(k) and move it into a taxable brokerage account. You have to withdraw the rest of your assets from the company plan in the same calendar year, most likely moving that balance into an individual retirement account to continue deferring taxes.

And to be able to do this, you must have a "triggering event," typically reaching age 59&frac12; or leaving your job. (For more information, go to and look up the instructions for Form 4972 and Publication 575.)

When you withdraw the stock from your 401(k), you pay income tax on the shares' original purchase price, or "cost basis," Mr. Brown says. But any gain on your shares while they were sitting in the 401(k) -- the net unrealized appreciation, or NUA -- will be taxed (whenever you decide to sell the shares) at long-term capital-gains rates. Those rates currently top out at 15%. In contrast, if you roll your company stock into an IRA, all withdrawals are taxed at ordinary income rates -- as high as 35%.

If you withdrew the stock from your 401(k) a few years ago, and you sell it now, you also would have either a long-term capital gain -- or loss -- on the stock's value since the distribution. Let's say the stock's basis was $20,000 and the NUA was $100,000, for a total $120,000 market value when you moved it from your 401(k) to your brokerage account in 2005. Now, if the stock has appreciated another $30,000, you would have a long-term capital gain of $130,000. But if the market value has dropped to $100,000, you would owe capital gains tax on $80,000, reducing the taxable amount by $20,000.

Write to Kelly Greene at

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