Own Stocks? Learn About NUA

The tradeoff: 

The ordinary income tax will be due on the transfer of the stock during the year in which it is made. It is also possible that you will be required to pay a penalty of 10 percent on the cost basis of your shares when you take advantage of your lump-sum distribution before reaching the age of 59.5.



Whenever the stock appreciates more than one year after distribution, you will have to pay long-term capital gains tax on it.

Once a person reaches the age of 59.5, leaves their employer, or dies before NUA treatment becomes effective, all vested assets in their employer's retirement plan must be transferred in a lump-sum distribution.

The stock does not qualify for required minimum distributions since it is not part of a retirement plan. If you die before the money is withdrawn from your account, it will be kept in that account until your death. This will result in your heirs receiving a stepped-up basis for the appreciation in your stock during the period that you held it in a taxable account in addition to your NUA over the period that you held it in a taxable account. To gain a better understanding of this, contact a professional through YokeTax’s free consultations. 

Unrealized net appreciation can't be cured with a single solution. The employee will pay the lowest taxes and receive the money as soon as possible if they are older and have substantial appreciation in the company stock. 

Net Unrealized Appreciation

When you distribute your 401(k) holdings, you must pay taxes on investment gains. It’s possible to use NUA as a tax strategy to avoid a higher capital gains tax, but be sure to utilize a tax pro to make sure you’re going about things correctly.

NUA may prove to be valuable in income gap years, when people don't receive Medicare, Social Security, or other benefits until a few years after leaving their jobs.

Distributing Assets

There will be a time in every person's life when they must make a decision on how to distribute their assets. This usually occurs during a career change or retirement. If you take distributions from a retirement plan, you may be eligible for a little-known tax break (NUA) that could lower your tax bill if you are aware of the rules.

“The gains you accumulate with appreciated company stock can result in capital gains taxes or regular income taxes, depending on whether you file for capital gains or regular income taxes,” according to Mitch Pomerance, Vice President of Fidelity Investments.

You can distribute company stock under NUA if your retirement plan includes it. Moreover, because the NUA allows taxpayers to defer capital gains on part of their tax-deferred assets throughout their life, they are able to pay a lower capital gains rate on "part" of their tax-deferred assets when they are removed from it, as Pomerance points out.

Expanding on NUA

Stocks are valued at their initial costs minus their current market values, which is their cost basis. Assume you spent $2000 on 100 shares of company stock for $20 per share as part of your plan. If you bought the shares five years ago for $35 each, your cost basis would be $2,000 and your NUA would be $1,500.

NUA: What is the purpose of knowing about it? You have two options if you decide to distribute your company stock or the cash value of your 401(k) plan to your family. The first is to roll over the remaining assets into another 401(k) plan or distribute it into a taxable account and then roll it over into another 401(k) plan. The second option is to distribute the stock into a taxable account and then roll it over to another 401(k) plan. Depending on your state, how the IRS regulates NUAs will determine which option is the most effective for you.

If you transfer assets from your 401(k) plan to a taxable account, you will have to pay income tax on those assets.

In the case of company stock, the only tax you have to pay is on its cost basis. You are not taxed on any gains made since you purchased it. Direct, in-kind transfers of company stock to an IRA will result in the loss of the special benefits of the NUA for company stock. 401(k) plans may have the option of not rolling over or distributing company stock if you are under the age of 59.5 (If you are under this age, you will also be subject to a 10% early withdrawal penalty). 

You will be required to pay long-term capital gains tax on the distribution you receive as well as the profit you make on the sale of your shares when you sell them. The tax rate on capital gains is currently at 20%, much lower than the top income tax rate of 37%, so you might be able to save a considerable amount of income on taxes.

“If you have a low cost basis on your 401(k) position, it may make sense to take the tax hit now rather than later on a larger amount of money," says Pomerance.

What is the best time to choose a NUA tax strategy?

If you are wondering whether you should transfer your stocks to your taxable account or invest in an IRA, you should consider the following factors:

Tax rates: The NUA tax treatment of stock is more advantageous when regular income tax rates differ from capital gains tax rates.

Absolute NUA: The higher the dollar value of stock appreciation, the more you can save in taxes under NUA.

Percentage of NUA: As more proceeds are taxable at the lower capital gains tax rate and fewer at the highest income tax rate when a NUA represents a larger percentage of the market value, a greater tax savings is possible.

Time horizon to distribution: IRAs or taxable accounts aren't good candidates for NUA if you plan to hold your assets until liquidation. NUA elections, however, are more appealing if they are limited in time.

Feel free to contact us in a free YokeTax consultation with any further questions you may have.