Many people will make use of a 401(k) to contribute towards their retirement savings while they work. Typically when you leave or retire, the next step would be to roll the money into an IRA and continue investing in the same way you have been. However, one thing to consider is if you have been able to purchase your own company’s stock while you were working. A tax savings strategy you can utilize when you have company stock is Net Unrealized Appreciation.
Net Unrealized Appreciation (NUA) is the increase in value or appreciation of company stock held within a qualified employer retirement plan, such as a 401(k). “Unrealized” refers to the fact that it has not been taxed yet. NUA comes into play when you take a lump-sum distribution from your plan and choose to take the company stock “in-kind” rather than to cash out within the plan or rollover to an IRA.
When this lump-sum distribution is made, the cost basis of the stock is immediately taxed at ordinary income. The remaining unrealized appreciation is left to be taxed at capital gains rates once the stock is sold in the future. This can be an opportunity for tax savings as capital gains rates are lower than ordinary income tax rates. Without the use of NUA, the entire value of that stock would eventually be taxed at ordinary income rates.
In order to make use of NUA, a few requirements must be met.
- The lump-sum distribution must be the full account balance, not just a partial distribution.
- The distribution must be made following a qualifying event.
- Reaching age 59 ½
- Separation from service
- Disability
- Death
- The employer stock must be distributed in-kind, not sold within the plan
- The NUA must come from a qualified retirement plan, not an IRA
Making use of NUA tax treatment is typically beneficial when you have a large amount of highly appreciated company stock in your retirement plan. Also, when you are in one of the higher tax brackets, the difference between ordinary income tax and capital gain tax will be much more noticeable.