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 an NUA (Net Unrealized Appreciation) opportunity to consider.
What is Net Unrealized Appreciation Anyhow?What is this NUA, 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 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 a 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 the 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 by 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 doing an NUA and rolling over the stock into an IRA along with the other investment assets held in the employer plan.
- If your income is between $0 to 39,375(single), or $0-$78,750(joint), your long-term capital gains rate is 0.
- If your income is between $39,376-$434,550(single), or $78,751-$488,850(joint), your long-term capital gains rate is 15%.
- If your income is over $434,500(single) or $488,850(joint), your long-term capital gains rate is 20%.
WOW thanks for the Article. I am having some issues right now trying to execute on this principle and the 401K management company has no clue how to process this transaction (more precisely fill out the 1099R form correctly.) I was wondering if you could comment on that assuming for example a common stock purchased at $1 with a Market Value of $10. This stock of course is in the company in which the 401K plan was issued. Near as I can tell Box 1 would be $10 and Box 6 would be $9 but I can not seem to understand what Box 2a and 2b (Taxable amount) and what the distribution code would be for this process.
Excellent article, but I’m wondering…is there is a definitive answer to the “one year” rule?
I’ve been told that the NUA rollover doesn’t have to be completed within one year of a triggering event, just that entire 401k account (company stock and anything else in it) has to be completely transferred out of the 401k within a single tax year (but, that tax year could be several years after the triggering event). A definitive answer about that would be very useful.
Also, I have another (maybe odd) question…
Is there anything that might be what could be called a “NUD” (Net Unrealized Depreciation)?
I have a 401k with a company I’ll call ABC. My ABC 401k has ABC company stock in it that has appreciated a good amount and would be a candidate for an NUA.
But, as it turns out, I have a second 401k (with a company I’ll call XYZ). I have XYZ company stock in the 401k I still have with XYZ. However, my cost basis for the XYZ company stock is substantially HIGHER than its current value. Is there something that would let me roll XYZ company stock out of the XYZ 401k into a taxable account and claim the capital LOSS? (Kind of like a NUA, but in reverse.)
If so, I’m wondering if I could execute the NUA on my ABC 401k and there “NUD” on my XYZ 401k and use the capital loss on the XYZ stock to partially offset the normal income tax I’d have to pay on the basis part of my ABC NUA?
Thanks. Studying up on stock concentration and diversification This was very helpful.
Slight correction… the lump sum distribution does not need to take place within one year of the enumerated events set forth in 2., above. The distribution must be a lump sum distribution, which is defined to be a distribution in one tax year. For example, if the employee retires at age 55, or if she separates from service, or becomes disabled, she can keep her retirement assets in the company 401k (assuming the plan permits it) until she decides to take it out. When she does decide to take the employer company stock out of the 401k, the rest of the 401k must come out prior to December 31 of that year, and not the following year.
As to death, some plans allow a beneficiary (typically a surviving spouse) to leave the 401k intact for some period of time following the death of an employee. The beneficiary can harvest the NUA, but must evacuate the entire 401k in one tax year, rolling the 401k to an IRA being the most common approach.
I need clarification, your article states
In order to set up an NUA, there’s a long list of requirements that must be met:
1.The employee must take a lump-sum distribution from the retirement plan.
In order to set up an NUA, there’s a long list of requirements that must be met:
2.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.
In all my research I have not heard that the lump sum distribution must be taken within one year of a “triggering event”, please clarify
I have been told that I cannot use NUA if I have previously withdrawn funds from the 401K account which I have because of the required minimum distribution. I have separated from my employer for many years. Is this true??
Hi Jim – I’d love to tell you I have a definite answer. But NUAs are complicated, and I recommend either discussing it with your plan administrator, a CPA or both. And if the CPA says yes, and the administrator says no, the CPA will need to cite the IRS source to support it.
I think you are confused on the one year rule. I think it says you have to take full distribution on one tax year. But no in one year after a qualifying event. I have been retired two years and I think I can still do a NUA on my 401K. From https://www.fidelity.com/viewpoints/personal-finance/company-stock it says:
“You must distribute your entire vested balance in your plan within one tax year (though you don’t have to take all distributions at the same time).”
That is where one year comes in.
Hi Arthur – Or does that simply mean you can take several distributions within the one year?
Great article with loads of information. As one proceeds with executing the NUA you covered income taxes on the cost basis but what about social security and medicare taxes on this reportable income for the year you execute the NUA transaction?
Hi Julie – The NUA isn’t subject to FICA tax, nor to the 3.8% Medicare Surtax.
If I am passed 70½ and I have company stock, can I transfer within 1 year after retirement to brokerage co in kind, and remaining mutual fund to rollover.
Company stock can be counted as rollover.
2nd question can I transfer partial co stock in kind to NUA and partial to rollover ?
Hi Arun – You’ve got a lot you’re planning to do. I’d contact your HR department or your accountant and see what your options are.
The 401k provider will not provide a written copy of the cost basis for each share purchased through my 401k. They claim they do not have the information. Are they required by law to provide me with the information? Any suggestions on how to make them provide me the information? I’ve been asking for over 6 months.
Hi Lorey – There are a few reasons why that may be. If the stock was purchased under a different plan, that could be the problem. There may also be a time limit. Brokerages have only recently been required to provide cost basis, so if you purchased the stock a few years ago they may not have the information. Maybe see if they can pull up old statements, which may go back a lot of years if you’ve been purchasing the stock over many years. They may charge a fee to get the information out of storage.
I have a large amount of company stock roughly 4X the cost basis. I am worried about moving to a taxable account as opposed to rolling over to an IRA and what to do with the remaining funds. I assume they can go to IRA but I would like to deal with a local CPA to figure this out. Any thoughts, I am located in Massachusetts.
Hi Rich – Ask for referrals for a good CPA. This question may need some research, so you may not be able to get a quick answer over the phone.
I’m a little confused about #2 under the qualification explanation: “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.”
I retired early from the company I worked for due to the money I made in company stock ESPP and options. I also went 100% stock in my 401K. While I left the company around 10 years ago…I won’t reach 60 years old until next year. I kept the 401K in the company sponsored account and have been reinvesting the dividend. Can I still take advantage of the NUA within a year of the reaching the min. age of distribution….or am I disqualified because I left company over a year ago?
Hi Ross – I’m not sure about the rules after 10 years, so it’s best you check with your plan sponsor or your tax preparer. There may be a loophole (there always seems to be with tax regulations), so it’s worth investigating.
my caution is based on 401k rollover to ira……
do not roll a 401k into an existing after tax ira as you will spend 40 hours each year explaining commingling
it is a nightmare…
in my case using NPV using 2% inflation and 6% ror the defer option was better
Excellent article!!! I didn’t realize there were so many rules surrounding NUA and now find myself forced to make a decision this year due to a pending merger. I am retired but kept my 401k with the company (COL). I have not done anything that would preclude taking advantage of NUA. However, my former company (COL) is being acquired by (UTX) in 2018. UTX will pay $140 for each share of COL stock ($93.33 in cash plus fractional shares of UTX stock equivalent to $46.67). The COL 401K plan said it will let us buy additional UTX shares with 93.33 cash portion if desired. My questions below relate to NUA after the completion of the cash/stock merger. What’s the best way to preserve my original NUA advantages in a merger that’s not an all stock transaction?
If I make an LSD before the merger and put COL stock in a brokerage account, won’t the eventual merger (cash 7 UTX stock) be treated as a sale of the COL stock and trigger capital gains taxes due in 2018?
If I let the merger complete while still in the COL’s 401K, won’t I lose the original basis of the COL stock for NUA purposes? Any help or comments would be highly appreciated!
Hi Bill – That’s a lot of variables. My thinking is that the companies will put out a statement explaining your options. You’re probably not the only one who will be affected. In the meantime, I’d discuss the situation with a CPA. I have some knowledge on NUAs, but I’m not an expert. Your situation is very specific.
I have both company stock qualifying for NUA treatment and non-company assets in my 401K. I’m turning 70 1/2 in January 2018 and planning to distribute the company stock to my stock market margin account and the non-company portion to my traditional IRA on the understanding that I need to fully liquidate the 401K to take advantage of the NUA tax treatment. My questions are whether I can leave the assets transferred into the IRA for multiple years (subject to minimum mandatory distributions), and whether I can leave the company stock in my margin account, having only paid taxes on the purchase basis, for many years possibly even selling covered call options on the stock or whether I’m required to liquidate (or at least pay capital gains on the remaining value of the stock and reset the cost basis) the stock in the same tax year and pay long term capital gains tax it.
That sounds right Kenneth. You don’t have to sell anything. The margin account isn’t subject to RMDs so there’s nothing you have to do there until you’re ready. But consult with a tax preparer if you have more specific questions.
Hi Jeff, thanks for the thorough article on NUA. I’m a CFP who works with NUA on a very regular basis, and I had a question on requirement #2 you listed, “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.”
I’ve never heard of this requirement to take advantage of NUA within one year of the qualifying event. I’m not sure if this is a reference to IRC 402(e)4Di, but my understanding is this is simply defining a lump sum as a complete distribution of the account within one tax year. My understanding on NUA is that it can be taken advantage of at any time after a qualifying event, as long as that qualifying event hasn’t been waived by taking a partial withdrawal in a prior year.
Am I understanding your position correctly that the window of opportunity to exercise NUA is within one year of a qualifying event? If so, can you provide me with a source for this information? This difference would drastically change the advice I give to many of the customers with whom I work.
Thanks again for your time and answer. I love your stuff.
Hi Nate – That’s the rule as I understand it. Fidelity says something similar in their discussion of NUAs.
Hi, also of concern in these situations is estate planning. My research seems to indicate that the stock would not receive a step up to market value upon inheritance. Inheritance of a tax deferred account can be treated in several different ways so in the long run keeping the funds tax deferred and taking RMW’s may work out better as a whole if those are considerations in one’s planning.
In my case I would save roughly 160k in taxes if I liquidated the 401k. That amount would be made up over time by earnings on the funds that would have been paid in taxes thus defeating the immediate benefit of the lower taxes and my heirs could inherit the tax deferred account providing them with an income.
I have not included all the details trying to keep it simple but there should be enough for general observations.
Am I missing something or do you agree with the general premise?
Hi Tom – That’s a very specific situation, and NUAs are complicated enough as it is. Please discuss this with a CPA. A mistake can be costly.
Firstly, your custodian should be able to tell you whether you have n u a stock in your account. However, your custodian or financial advisor is not going to be able to tell you the tax consequences of that transaction. In order to determine the tax consequences, someone needs to look at your prior-year return and forecast your current or expected income to determine the implications for tax purposes of an Nua rollover. Another important thing to consider about the NUA strategy is that although you may qualify, its important to make sure you don’t have a disqualifying event, such as a distribution or a loan from your 401k. As such, aside from analyzing the factors that qualify you, take a look at the tax implications of the lump sum distribution, how the distribution of the Nua stock is going to affect your taxes, and how much tax you’re going to owe in the current year. In addition, you need to know when to make your estimated tax payment. Furthermore, you should know what to expect from the custodian by way of documentation of the Nua stock. Moreover, you should be fully aware of the basis, or the purchase price of your Nua stock. The basis is important as is the accounting method by which you account for your transaction for income tax purposes. This means are you using first in first out, last in first out, specific identification, or weighted average methods. You should consider the consequences of selling all of your NUA stock, and distributing only part of your NUA stock to a taxable account, while rolling over the remainder to an IRA. If you choose this, you’re going to need to decide which lot of the stock you should roll over, if it benefits you to do so. In this regard, you can choose which accounting method to use that best suits you for the transaction. In conclusion you should also have some level of assurance from your tax consultant or Tax Advisor that would help you in the event the IRS chooses to examine your return or has questions about your Nua transaction.
I am recently retired (at 76) and have a large amount of company stock in my 401k. Half has substantial gain (good for NUA) and half is near market value. Do I need to take all out to a non-Ira account or can I take only the portion that is relevant to NUA? I do not intend to sell the stock.
In addition do I need to take a total rollover of all funds at the same time that I take the stock? I also have to take a required distribution.
Hi Dick – One of the rules is that you will be required to take a full distribution. You can put the non-stock portion into the IRA rollover. I believe that you will have to do the rollover at the same time that you take the stock, since the entire employer plan must be liquidated to get the NUA.
But please discuss this with your accountant before you take the plunge. Tax brackets – including the tax bracket after any distributions – will impact the value of the NUA.
I would advise a client that legally speaking, the IRS allows the basis of the stock to be allocated among the shares, so that you can distribute NUA stock in lots, as you see fit. But you would need a CPA such as myself to sign off on it, as well as the fact that you would need to be eligible for the lump sum distribution and otherwise not disqualified, as it needed to be done within 1-calendar-year following the triggering event. But if I understand your question, it is possible with the right support team. Also, under Treasury Regulations the NUA distribution counts as a Minimum Required Distribution for the Fair Market Value, not just the cost basis of the stock distributed in the lump-sum distribution/rollover. This is not advice, but rather a suggestion that you seek counsel.
SO I understand if I have a great deal in a 401k and I was just laid off so I’m in a 25% bracket at most. However only 15% is in stock
Can I rollover the 85% into an ira and the 15% to a taxable account (can I do this with Charles Schwab for instance?) than liquidate it.
I’m 55 so I pay 10% penalty and ordinary income on the cost basis and ordinary income as well than capital gains of probably 15% on the NUA
Am I correct on this whole scenario?
Hi Jack – I believe that you can put 85% into an IRA and the company stock into a taxable account. You will pay tax only on the cost of the stock in your 401K but not the 10% prepayment penalty. The stock can then be sold at the long-term capital gains rate. Please check with your plan administrator and/or accountant to make sure you can.
I am just over 70.5 years. I have executed a LSD from my company 401K including taking advantage of an NUA to pull out company shares and satisfy the RMD. The shares have transferred from the 401K to the share holding company. The shares are registered to my name as individual (because the 401K was only in my name – with my wife as beneficiary). Is it wise and acceptable to re-register the shares as Joint Tenant with Right of Survivorship? Will re-registering violate any rules of the NUA?
Hi Gordon – I would discuss that question with the broker or trustee. On the surface, I’d say it isn’t a problem because it’s after the fact, but please dig deeper into it before you do it.
I would advise the client to seek a legal opinion as it may depend upon whether you reside in a community property state and what your estate plan calls for. You can’t re-register the ownership of your new IRA; you only may name a beneficiary. When you re-title your taxable financial account holding the NUA gain stock, you presumptively make a gift of the shares to all those on the title. The value of the account has significance, as does your estate picture. It also may be a factor as to whether you are married filing jointly or married filing separately. Your tax consequence could change. Under Federal tax law, you can generally give an unlimited amount to your spouse. But as far as tax consequence, under a hypothetical scenario, gifting to your spouse generally has no tax consequence as far as gift taxes. Please seek a qualified tax and legal counsel.
Hi Jeff —
Just finished reading this excellent article on that unrealized appreciation. Now that I’m working at Morgan Stanley, I’m finding these kinds of transactions are more typical.
After reading this article, I realized I was reading your article!
Nicely done, my brother from another mother!
See you at FinCon15!
Jim Munchbach Just finished reading this excellent article on net unrealized appreciation. Now that I’m working at Morgan Stanley, I’m finding these kinds of transactions are more typical.
After reading this article, I realized I was reading your article!
Nicely done, my brother from another mother!
I am going to sell NUA stock I have had for 2 months. Can I claim a capital gains loss since the stock has dropped $6 per share. I know any gain since the distribution would be taxed as short term gain. But no website I have read ever mentions the reverse in their discussion.
Without providing direct advice, understand the general rules: upon the distribution of the NUA stock in a lump sum rollover, the basis of the stock is included in your ordinary income plus any applicable early withdraw penalty 10%. The Net Unrealized Appreciation is the difference between the basis and the Fair Market Value of the Stock at the date of the distribution. No matter when the stock was actually purchased, that part is ALWAYS long-term capital gain. Any subsequent gain is treated as a capital gain with the holding period beginning on the date of the distribution. So subsequent gains are treated as short term unless they are held for a year of more from the date of distribution. If the stock had a basis of $1, and had a FMV of $10 when distributed (NUA of $9), then if the stock went to $6, then the NUA would be $5. If on the other hand, the stock dropped below its basis to $0.50, then you would have a long-term capital loss of $0.50. This is precisely why people should engage a professional to analyze these matters prior to entering the transaction to see if it makes sense from all angles to do the transaction. I am sorry you did not have a good experience, if can be of help to you I would gladly assist. Good Luck!
I appreciate you providing this information I have been going around and around with an issue related to a 401k transfer to an IRA. Once I did this with a firm I was left with questions on how to direct my funds. They could not direct me, and that left a really bad taste with me. This was most helpful. Investment firms talk to women as if they are completely simple. Thank You!!!