.The following article on NUA – net unrealized appreciation – is meant to be educational and not specific advice. I assume my readers are big boys& girls and understand that. But in today’s climate I have to tell everyone again anyways – people might do something dumb and go hurt themselves! (like stick a fork in an electric socket or something – don’t do that!). Consult a qualified advisor before attempting tax planning strategies such as the NUA strategy discussed here
Do you own company stock in your 401k? Did you leave your company and are you thinking about rolling that money over into an IRA? If you are in this situation, don’t do anything until you read this article. First a few qualifying questions:
- Would you like to know a few ways to fund early retirement without tax penalties?
- Feel like getting a big tax break?
- Would you like to reduce future taxes too?
- Want some estate planning advantages on top of that?
If you answered yes to any of these, then it’s OK to keep reading!
If you are considering rolling a 401k balance into an IRA, and you own company stock in your 401k, you need to know about the tax rules surrounding net unrealized appreciation (NUA) of stock in a 401k plan. Here’s the benefit that few people know about (from the IRS website: Notice 2009-68):
If you do not do a rollover, you can apply a special rule to payments of employer stock (or other employer securities) that are either attributable to after-tax contributions or paid in a lump sum after separation from service (or after age 591/2, disability, or the participant’s death). Under the special rule, the net unrealized appreciation on the stock will not be taxed when distributed from the Plan and will be taxed at capital gain rates when you sell the stock.
Net unrealized appreciation is generally the increase in the value of employer stock after it was acquired by the Plan. If you do a rollover for a payment that includes employer stock (for example, by selling the stock and rolling over the proceeds within 60 days of the payment), the special rule relating to the distributed employer stock will not apply to any subsequent payments from the IRA or employer plan. The Plan administrator can tell you the amount of any net unrealized appreciation.
What is this saying about NUA?
It’s saying that if you own company stock in your 401(k) for example, and you follow special rules, there is a potential option of treating the gains in the stock as capital gains under the tax code. As opposed to treating the gains as income, which retirement plan assets are usually treated as no matter the type of investment. Let’s use a short example and set out some facts:
- you work at ABC corporation, a public company.
- you own a 401(k) balance with $225,000 and $100,000 of it is in ABC stock (given as part of a profit-sharing plan).
- we’ll assume that you have 10,000 shares priced at $10 each ($100,000).
- We’ll assume an average purchase price of that stock at $2.
- Therefore, the average value of the stock when acquired over the years = $20,000 in our example and it grew an additional $80,000 after you received it.
What is this rule saying? If you follow certain SPECIFIC procedures, you could take that stock out of the plan. Then pay income tax on only the $20,000 cost of acquisition. And only pay the capital gains tax rate on the $80,000 “gain” AFTER you sell it (and no one says you have to sell it right away). The tax treatment of company stock in a 401(k) is a hidden bonanza!
What are the benefits to you for using the NUA technique?
- Lower capital gains taxes on your investment vs higher income taxes (under current law: 15-20% maximum capital gains rate vs 39.6% maximum income tax rate).
- Early retirement advantages – this could give you access to penalty free cash and (coupled with the age 55 rule) could help you quit your job earlier if that is your goal.
- No future RMD – no required minimum distributions on this money later on. that’s huge!
- Estate tax advantages – under current step up rules, capital assets are treated much more favorably than retirement accounts after death.
If you own company stock, you would benefit from investigating the NUA situation. Here are a few (likely not all) of the things to be aware of:
- Rolling the 401k over to an IRA without following the special rules to remove the stock nullifies this benefit.
- Be prepared to pay the income tax on the “basis amount” (in the above example the 20k). But the benefits could outweigh that temporary cost. Just like converting to a Roth IRA could save a lot of future costs.
- If you are still working for your company, they may not allow an “in service distribution.” (bummer!).
- Get professional advice with the maneuver – this can be tricky and messing it up costs too much and the IRS doesn’t usually give mulligans.
NUA – Don’t Screw it Up Ok?
If you are in this situation, I recommend again seeking professional advice, from say a firm like ours! (enter commercial). We have a good team and network of professionals in the tax, legal, and planning fields with the expertise to help on these matters. If you’d like to talk to someone about this, give us a call at 888.278.9433 or schedule a time to talk to us here on our online appointment request page.
Note that this is one of those “upper income benefits” like 529 plans, that the President would like to eliminate to boost tax revenue. For now dumping NUA (and 529s for that matter) is likely DOA, but know that the shelf life of cool tax breaks like NUA may not be permanent.
Thanks for reading! And Read our disclaimer here please – this is an educational article and not meant to be advice directly to you. I don’t know you (yet). Consider consulting an advisor before trying this at home ok?
Note: if you’d like to get my top IRA rulings of 2014 quick fact sheet, click here and I’ll email it over to you.
For further reading, consider:
If you have further questions, contact us by: