Do you have company stock in your employer’s retirement plan and you:
- Are a longtime employee with the firm?
- Have recently changed jobs?
- Have otherwise separated from service with your employer?
Instead of rolling employer stock over into an IRA, taking it as a lump-sum distribution could qualify you for favorable tax treatment on the stock’s net unrealized appreciation (NUA).
What is NUA?
Each share of employer stock you receive is comprised of cost and appreciation. For example, say you bought a share of stock for $10 through your employer’s retirement plan. If the share is now worth $25, the appreciation is $15 per share ($25 value minus $10 cost). Since you have not yet sold the share, however, the appreciation has not been realized—thus, the term “net unrealized appreciation.”
In brief, NUA is a way to take advantage of long-term capital gains tax treatment for appreciated employer stock received as part of a lump-sum distribution.
When appreciated stock is rolled over to an IRA, the stock or its proceeds are taxed as ordinary income when they are withdrawn from the IRA.
If you instead decide to take an in-kind distribution of just the stock from your employer’s qualified plan and not roll it over, the NUA strategy can provide the potentially significant benefit of shifting what would otherwise be ordinary income to a long-term capital gain at the time of sale. Furthermore, if the stock is not immediately liquidated, any additional appreciation after the stock is distributed would be taxed at capital gains rates (short-term rate if held 12 months or less, or long-term rate if held longer).
Who Should Consider the NUA Strategy?
Determining whether the NUA strategy is appropriate for you depends on a variety of factors. You may potentially benefit if you:
- Have highly appreciated employer stock
- Are in a high tax bracket
- Can afford to pay current taxes
- Have a diversified portfolio
- Will avoid the 10 percent penalty on the distribution (If you separate from service during the year you become age 55 or older, and then receive a distribution from your former employer’s retirement plan, you will not be subject to the 10 percent penalty.)
Why Consider the NUA Strategy?
- Long-Term Capital Gains Rates–potential tax savings attributable to the federal long-term capital gains tax rate, which is typically lower than the tax on ordinary income.
- Deducting Your Losses–in the event the value of your employer stock declines below your original cost basis while you hold it outside an IRA, you may be able to sell it and deduct the loss against realized gains you have that year. Inside an IRA or 401(k) this would not be possible.
- Preserving Your Estate–tax on the NUA portion of stock held outside an IRA is deferred until the stock is ultimately sold. Your beneficiaries are responsible for capital gains taxes on the accumulation that occurred inside your employer’s retirement plan. Any further accumulation that occurs after distribution and up until the time of your death may receive a stepped-up cost basis, which means that this accumulation will pass to your beneficiaries free from federal income tax or capital gains tax.
How do you Take Advantage of NUA?
When it’s time to take a distribution from your retirement plan account, elect to receive employer stock directly. Rolling it over into an IRA causes it to lose eligibility for NUA tax treatment so you must make this decision at the time of the distribution. You may possibly elect to use the NUA treatment on a portion of shares and roll over the remainder to an IRA. This is one of the rare instances when it might make sense not to roll over your entire distribution. Due to the highly complex nature of retirement plan distributions, we should discuss your options and you should talk to your legal and/or tax adviser before making any final decisions.