Many workers receive company stock as part of their compensation package or can take advantage of a company 401(k) plan, choosing from a menu of mutual funds, exchange-traded funds and company stock for their investments.
In retirement, how you distribute that company stock will play a key role in determining your tax liability for its value.Â
In the realm of investment and retirement planning, the concept of Net Unrealized Appreciation (NUA) holds significant importance. Understanding NUA can provide a unique opportunity for individuals with highly appreciated company stock in their employer-sponsored retirement plans.
In this comprehensive guide, we will explore the intricacies of NUA, its benefits and considerations, and provide practical insights to help you make informed decisions regarding your retirement assets.
What is Net Unrealized Appreciation?
NUA is a tax strategy that applies to individuals who hold employer stock within their employer-sponsored retirement plans, such as a 401(k). It allows the individual to potentially pay lower taxes on the appreciated value of the employer stock when it is distributed or sold.
NUA offers a unique opportunity to separate the stock’s appreciation from other retirement plan assets and potentially benefit from favorable tax treatment.
When utilizing the NUA strategy, you must take a lump-sum distribution of all the assets in the employer-sponsored retirement plan account. The employer stock is distributed in kind and is usually moved to a brokerage account.
The remaining assets may be rolled over. Additionally, you must distribute the entirety of the vested balance held in the plan within the calendar year, including all assets sponsored by the same employer.Â
Watch to Learn More About Calculating NUA
How Do I Qualify for NUA?
NUA is applicable to certain employer-sponsored retirement plans, such as 401(k) plans, that hold employer securities.
Qualification for NUA typically requires a specific triggering event, such as retirement age, leaving the company or becoming disabled. Each retirement plan may have rules regarding when and under what circumstances NUA is allowed.
We recommend reviewing your plan’s documentation or consulting with the plan administrator to understand the triggering events.Â
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What Are The Tax Benefits to NUA?
NUA offers a range of tax advantages that can help individuals maximize their after-tax returns and potentially reduce tax liabilities to achieve greater tax efficiency. Let’s take a look at four key tax benefits of NUA.
Capital Gains Tax Rates
One of the primary tax benefits of NUA is the potential to pay capital gains tax rates on the appreciated value of employer securities rather than ordinary income tax rates.
When you distribute the securities from your retirement plan and sell them, the NUA (the difference between the original cost basis and the current fair market value) is taxed as a long-term capital gain.
Capital gains tax rates are often more favorable than ordinary income tax rates, especially for securities held for more than one year.
Tax Deferral
NUA allows you to defer taxes on the appreciation until you decide to sell the employer securities. By distributing the securities as part of a lump-sum distribution from your retirement plan, you delay the tax liability on the net unrealized appreciation.
This deferral can provide potential tax advantages, as you have more control over the timing of realizing the gain and can potentially take advantage of lower tax rates in the future.
Portfolio Diversification
NUA can help you diversify your retirement portfolio. By distributing the employer securities and holding them outside of the retirement plan, you create an opportunity to diversify your future tax liability.
This can be particularly beneficial if you anticipate being in a lower tax bracket when you sell the securities, as you can take advantage of potentially lower capital gains tax rates.
Estate Planning Benefits
Utilizing NUA can also offer potential estate planning benefits. Under one NUA strategy, when you distribute the employer securities to heirs or beneficiaries upon your passing, they will only pay long-term capital gains (LTCG) on the difference between the original cost basis and gains after the original NUA distribution but before date of death.
The step-up is limited to gains after NUA distribution and fair market value on the date of death. This step-up in basis can minimize the capital gains tax liability for your beneficiaries if they choose to sell the securities.
As an example, a retiree had company stock worth $150,000 and a cost basis of $25,000 on the original NUA distribution date. The retiree paid ordinary income tax on the $25,000 cost basis at that time. Years later, the retiree died when the stock had a value of $275,000. The heirs will only owe LTCG on the NUA amount of $125,000 ($150,000 minus $25,000) and not on the difference between $275,000 and the $25,000 original cost basis. If the heirs wait to sell until later, gains after death do not receive a step-up.
What Are The Risks of NUA?
NUA offers certain advantages when managing retirement plan assets but also has some inherent risks. It’s important to understand these risks before considering this strategy.Â
Tax Implications
While NUA can provide tax benefits, navigating the associated tax implications carefully is essential. Distributing the employer securities, which have appreciated in value, may trigger immediate tax liabilities on the original cost basis. This can result in a higher tax bill in the short term.
After thoroughly reviewing your financial picture, one NUA strategy we often employ can reduce or eliminate the potential ordinary income tax liability on the original cost basis.Â
Concentration Risk
NUA distributes highly appreciated employer securities from a retirement plan. By doing so, you may end up with a concentrated position in a single stock or a few stocks.Â
This concentrated exposure can increase the vulnerability of your investment portfolio to the performance of those specific securities. If the value of those securities declines significantly, your overall portfolio could be negatively affected.
Lack of Diversification
Utilizing the NUA strategy might reduce diversification within your retirement portfolio. By holding a large portion of your assets in employer securities, you may be exposed to the risks associated with a single company or industry.
Diversification is a key risk mitigation tool, and a lack thereof could impact the long-term performance and stability of your investments.
Future Tax Law Changes
Tax laws and regulations can change over time. While the NUA strategy may currently provide tax advantages, future legislative changes could impact its benefits.
It’s essential to stay informed about potential tax law modifications that could affect the NUA strategy and its associated risks and rewards.
Watch to Learn More About the Potential Drawbacks of an NUA Planning Strategy
How Is NUA Calculated?
NUA measures the appreciation in the value of employer securities held within a retirement plan. Calculating NUA involves determining the difference between the original cost basis and the current fair market value of the securities.
For example, say you retire with 1,000 shares of the company’s stock. You originally paid $10 per share, but they are now valued at $50 per share. The difference between those two values, $40, is the NUA and represents the amount applicable to capital gains tax, which is typically lower than ordinary income tax rates.
View Our NUA Playlist on YouTube For Real-World Applications
Can NUA Apply to Any Type of Retirement Plan?
The NUA strategy applies specifically to certain types of employer-sponsored retirement plans, namely 401(k) plans.
The NUA rules allow individuals who hold employer securities within their 401(k) plan to potentially take advantage of the tax benefits associated with distributing and selling those securities. However, it’s important to note that not all employer-sponsored retirement plans are eligible for NUA.
Other types of retirement plans, such as Individual Retirement Accounts (IRAs), do not qualify for the NUA strategy.
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Should I Work With a Financial Advisor for NUA Planning?
NUA can be a valuable tool for individuals with highly appreciated company stock within their employer-sponsored retirement plans.
By understanding NUA, its benefits and considerations, and implementing it with careful planning, you can potentially optimize your tax strategy and make informed decisions regarding your retirement assets.Â
Konza Global Wealth Group has the expertise and experience to ensure that distributions are handled properly so company stocks don’t lose NUA eligibility through missteps.
We incorporate tax planning strategies into your financial plan to minimize the tax bite and, most importantly, potentially provide more income during your retirement years.
Contact a Konza Global advisor to review your individual portfolio or with other financial concerns. Â Take our complimentary risk score assessment to determine how much risk you can handle over the short term to hit long-term goals.
Also, make sure to follow our YouTube channel or other social media accounts for more financial planning tips.Â
Important Note
This material is provided for educational purposes only and does not constitute investment advice. The information contained herein is based on current tax laws, which may change in the future.
Konza Global Wealth Group Advisors cannot be held responsible for any direct or incidental loss resulting from applying any of the information provided in this publication or from any other source mentioned.
The information provided in these materials does not constitute any legal, tax or accounting advice.
Please consult with a qualified professional for this type of advice. The information provided above is obtained from publicly available sources and is reliable. However, no representation or warranty is made as to its accuracy or completeness.
