Many employers allow employees to buy company stock inside their retirement plan which is sometimes eligible for special treatment under the tax code. If you’re planning to retire or change jobs, and you have a significant amount of highly-appreciated company stock, the little-known IRS net unrealized appreciation rule could save you a significant amount on taxes.
What is Net Unrealized Appreciation?
Net unrealized appreciation (NUA) is an IRS rule that offers potential tax savings by letting you pay tax on the value of the stock when you originally received it (or the cost basis) rather than its current market value. The difference between the cost basis and the stock’s current value (the NUA) is not subject to tax until the stock is sold, and when you do sell it, the NUA is taxed at a capital gains rate, which may be significantly lower than ordinary income tax rates. NUA is also not subject to the 3.8% net investment tax those in higher income brackets may be subject to.
Qualifying for Net Unrealized Appreciation Treatment1
You must meet all of the following criteria to take advantage of the NUA rule:
- Distribute the entire vested balance in the plan within one tax year
- Take the distribution of company stock in kind and transfer it to a non-IRA account.
- If there are any non-company stock assets in the account, those assets may be rolled to an IRA. If the company stock is rolled into an IRA, then the ability to use the NUA tax treatment is lost
- Experience one of the following:
- Separation from service from the company whose plan holds the stock (except in the case of self-employed workers)
- Be at least 59½
- Total disability (for self-employed workers only)
- Death (at which time your beneficiaries can apply NUA)
When to Apply the Unrealized Appreciation Rule
Although NUA has its benefits, you may not come out ahead financially if you factor in the tax-deferred growth potential you may achieve by rolling company stock into a traditional IRA. The following factors can help determine when to take advantage of the NUA rule, but we strongly recommend talking to your financial professional on this complex strategy.
- Tax rate: NUA tax treatment will work best for taxpayers that have a significantly higher ordinary income tax rate versus their capital gains tax rate.
- Appreciation of the stock: NUA rules work best when there is a large amount of appreciation on the company stock.
- Distribution time horizon: If distributions are to be taken immediately, then the NUA election is more attractive.
- Leaving stock to heirs: If an individual wants to leave the company stock to their heirs, NUA is more attractive.
An Example of How it Works:
Taxpayer age: 60
Ordinary income tax rate: 39.6%
Long-term capital gains tax rate: 20%
Total value of company stock: $100,000
Cost basis of company stock: $20,000
NUA Amount: $80,000
What Happens When You Roll the Stock Into an IRA?
Without the use of the NUA rule, the entire $100,000 would be taxed at the ordinary income tax rate of 39.6% if the stock is rolled into the IRA and immediately withdrawn. The total tax due is $39,600.
What Happens When You Apply the NUA Rule?
With the use of the NUA rule, you would pay ordinary income on the cost basis of $20,000. The tax due on the basis is $7,920. If you then immediately sell, the tax on the NUA portion of $80,000 would be 20% or $16,000. The total federal tax due would be $23,920 or $15,680 less than the tax due on the non-NUA treatment.
Talk to Your Financial Professional
The NUA rule can be a very effective way to save on taxes, but it’s also a complex approach that may not be the best choice based on your unique financial situation. If you’re thinking of making a change in your employment status that may cause you to benefit from the NUA tax exclusion, talk to your financial professional. They can walk you through each tax scenario to help determine which approach may be right for you.
1https://www.forbes.com/sites/kristinmckenna/2021/09/08/net-unrealized-appreciation-rules-for-company-stock-in-a-401k/?sh=3bcd02184373
Some referenced materials may be outdated. Individuals are advised to consult the most current data or official sources before making decisions.
Cetera Financial Group (Cetera) is a network of independent retail firms, including those that are members of FINRA/SIPC: Cetera Advisors LLC; Cetera Wealth Services, LLC (formerly known as Cetera Advisor Networks); Cetera Investment Services LLC (marketed as Cetera Financial Institutions or Cetera Investors); and Cetera Financial Specialists LLC. Entities registered as investment advisers with the Securities and Exchange Commission include Cetera Investment Management LLC and Cetera Investment Advisers LLC. Cetera’s principal office is located at 655 W. Broadway, 11th Floor, San Diego, CA 92101