Net Unrealized Appreciation (NUA): The Tax Strategy Many Retirees Overlook

Net Unrealized Appreciation (NUA): The Tax Strategy Many Retirees Overlook

If you have a large amount of company stock inside a 401(k), there may be a powerful tax-planning opportunity hiding in plain sight: Net Unrealized Appreciation (NUA).

NUA can potentially allow you to move appreciated employer stock out of a retirement plan and pay long-term capital gains tax on the stock’s appreciation instead of ordinary income tax when that appreciation is eventually realized.

For the right retiree, this can create a significant tax savings.

How NUA Works

Let’s say you have $1 million in a 401(k), including $300,000 of your former employer’s stock.

Imagine you originally paid $100,000 for that stock through your 401(k), and it has grown to $300,000.

That means you have:

• Cost basis: $100,000

• Current value: $300,000

• NUA: $200,000

If you simply roll the entire 401(k) into an IRA, you generally lose the ability to use the special NUA tax treatment on that stock. Future distributions from the IRA are generally taxed as ordinary income.

But an NUA strategy may allow you to distribute the company stock to a taxable brokerage account and roll the remaining retirement assets into an IRA.

The $100,000 cost basis would generally be taxable as ordinary income in the year of the distribution, while the $200,000 of NUA isn’t taxed until the stock is sold—and then generally receives long-term capital-gain treatment.

Any additional appreciation after the distribution is generally treated as a capital gain as well, with the character depending on how long the shares are held after distribution.

Why This Can Be So Valuable

The difference between ordinary income tax rates and long-term capital gains rates can be substantial.

For someone with a large amount of highly appreciated company stock, paying ordinary income tax on the entire $300,000 could create a much larger tax bill than paying ordinary income tax on the $100,000 basis and capital gains tax on the $200,000 appreciation.

But this isn’t simply a “pay less tax” strategy.

It’s a tax trade-off.

You are giving up some of the tax-deferred treatment of the retirement account in exchange for potentially converting a significant portion of the appreciation into capital-gain treatment.

There Are Rules

NUA is not something you can casually implement by taking a withdrawal from your 401(k).

The strategy generally involves a lump-sum distribution that satisfies specific IRS requirements, and the timing and structure of the distribution matter.

There can also be important considerations involving:

• Your age and potential early-distribution penalties

• The cost basis of the company stock

• How much the stock has appreciated

• Your current and future tax brackets

• State income taxes

• Capital-gains rates

• Medicare IRMAA considerations

• Required minimum distributions

• Estate planning

• Investment concentration risk

• Your overall retirement-income strategy

And perhaps most importantly, the decision should be made before automatically rolling the entire 401(k) into an IRA.

Once the stock has been rolled into an IRA, the opportunity for NUA treatment generally cannot simply be recreated later.

Don’t Let the Tax Tail Wag the Investment Dog

There is another important consideration.

If you’ve retired with $500,000 of your former employer’s stock, saving taxes isn’t necessarily a reason to keep $500,000 of your wealth concentrated in one company.

Sometimes the best strategy is to use NUA to receive favorable tax treatment and then diversify the stock.

The goal isn’t to minimize taxes at all costs.

The goal is to maximize after-tax wealth while managing risk.

The Bigger Lesson

NUA is a great example of why retirement planning is about much more than picking investments.

Two retirees could have identical $2 million portfolios but completely different tax situations depending on the type of accounts they own, the cost basis of their investments, their income needs, and their estate plans.

The question shouldn’t simply be:

“How much money do I have?”

It should be:

“How much of my money will I actually get to keep?”

If you have highly appreciated employer stock inside a 401(k), don’t automatically roll everything into an IRA without first determining whether NUA could benefit you.

Sometimes the biggest tax savings aren’t found in complicated investments.

They’re found in making the right decision before you move the money.

Click here to schedule a meeting — I’m here to help you take the next step toward financial freedom.

Colin Symons, CIO Lloyd Financial Group

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