I’ll never forget the conference call I had with a client who was getting ready to retire from the company she had worked for 20 plus years. She had saved as much as life had allowed her to and most was invested in the stock of the company which employed her all that time.Almost Pulled The Trigger…. We were ready to give the instructions to do a 401k Rollover right before we learned that her cost basis in the stock was very low and she had a NUA (Net Unrealized Appreciation) opportunity to consider. Upon learning that, we put it on hold and I had the luxury of trying to explain what Net Unrealized Appreciation rules were over the phone. If you don’t know, explaining NUA rules over the phone is not the wisest decision. Not having the visual benefit of really snazzy flow charts makes it very difficult. In a real way, net unrealized appreciation has to be seen to be fully appreciated.
What is Net Unrealized Appreciation Anyhow?What is this NUA already you ask? NUA is a favorable tax treatment on employer securities (usually stock) for lump-sum distributions from a qualified retirement plan. More and more companies are offering employer stock as an investment option inside their qualified plans, allowing NUA to provide a potentially lower tax bill. The net unrealized appreciation is the difference between the average cost basis of the shares of employer company stock that has been purchased over the years when it was accumulated, and the current market value of those shares.
The NUA is important if you are distributing highly appreciated company stock from your tax-deferred employer-sponsored retirement plan, such as a 401(k).
Qualifications For NUA To Work:In order to set up an NUA, there’s a long list of requirements that must be met:
- The employee must take a lump-sum distribution from the retirement plan.
- No partial distributions are permitted – the lump sum distribution must take place within one year of a) separation from your employer, b) reaching the minimum age for distribution, c) becoming disabled, or d) being deceased.
- The distribution must include all assets from all accounts sponsored by and held through the same employer
- All stock distributions must be taken as shares – they cannot have been converted to cash prior to distribution.
- The entire vested interest in the retirement plan must be distributed.
- The employee may be subject to 10% penalty for premature distribution if he or she is under age 59 ½, unless the employee meets an exception to the premature distribution penalty under section 72(t).
- The cost basis is the Fair Market Value (FMV) of the stock at time of purchase, regardless of whether the employer or employee contributed the money.
- The NUA does not receive a step-up in basis upon death, it is instead treated as income in respect of a decedent.
- If there is any additional gain above the NUA, the long-term/short-term capital gains will be decided looking at the holding period after distribution.
- No Required Minimum Distributions (RMDs) are required.
Why an NUA May be Better than a RolloverThis is certainly not true in all cases, but it can work to your advantage under certain circumstances. If your 401)k) plan does have a large amount of employer stock, and it has appreciated significantly, you should weigh the pros and cons between between doing an NUA and rolling over the stock into an IRA along with the other investment assets held in the employer plan.
- If your ordinary income tax bracket is 15% or less, your long-term capital gains rate is 0.
- If your ordinary income tax bracket is between 25% and 35%, your long-term capital gains rate is 15%.
- If your ordinary income tax bracket is at the top rate of 39.6%, your long-term capital gains rate is 20%.