Transform Your Retirement Plan with Net Unrealized Appreciation (NUA)
Empowering employees by offering ownership in company stock encourages an ownership mentality and has significant financial implications. Net Unrealized Appreciation (NUA) is the difference between the average cost basis of your shares in your employer’s stock and the current market value of those shares. NUA becomes crucial when distributing highly appreciated employer stock from tax-deferred employer-sponsored retirement plans like a 401(k).
Key Takeaways
- Valuable Difference: NUA reflects the difference between the original cost and the current market value of employer stock.
- Tax Advantage: The IRS allows a favorable capital gains tax rate on the NUA of employer stock upon distribution, contingent on qualifying events.
- Immediate Taxation: Ordinary income tax must be paid immediately on the cost basis of the employer’s stock at the time of distribution.
Discovering the Benefits of NUA
Distributions from tax-deferred retirement accounts are typically treated as ordinary income and taxed accordingly, often at a higher rate than long-term capital gains. Thankfully, the IRS provides an option for the NUA of employer stock to be taxed at more favorable capital gains rates, available only when the stock resides in tax-deferred accounts like a 401(k) or traditional IRA. Stocks held in Roth IRAs or regular brokerage accounts are not eligible for NUA treatment.
NUA: Weighing the Pros and Cons
Distributing employer stock from a 401(k) under NUA rules has unique tax implications. While most of your 401(k)’s market value is taxed as ordinary income, the employer’s stock will face ordinary income tax only on its original cost basis. Capital gains tax, often significantly lower, only applies once you sell the stock, translating to substantial tax savings.
However, this benefit requires paying ordinary income tax immediately on the original cost basis. As a mitigation strategy, distribute only shares with the lowest cost basis to minimize tax impact.
Essential NUA Requirements
To qualify for NUA benefits, specific requirements must be met within a year, including distributing all vested balance and assets from a plan sponsored by the same employer. Qualifying events include separation from the company, reaching minimum retirement age, total disability, or death.
Related Terms: 401(k), IRA, Roth IRA, Capital Gains Tax, Ordinary Income.
References
- Internal Revenue Service. “Publication 575 (2019), Pension and Annuity Income”.
