Net Unrealized Appreciation Tax Planning Strategy

What is NUA?

NUA stands for Net Unrealized Appreciation, which is a tax benefit available to individuals who hold employer stock within their employer-sponsored retirement plan, such as a 401(k). NUA allows you to potentially reduce your tax liability when distributing the employer stock from your retirement plan.

How does it work?

Eligibility: To take advantage of NUA rules in the Internal Revenue Code, you must meet certain criteria. You must be eligible for a distribution from your employer-sponsored retirement plan by having a triggering event, either due to retirement, job change, or reaching the plan’s required age for distributions. Additionally, the employer stock held within the plan must have appreciated in value since it was initially acquired. For this strategy to work, you typically must work for a publicly traded company with shares available on a stock exchange.

Distribution of Employer Stock: Instead of rolling over your entire retirement plan balance into an Individual Retirement Account (IRA) or another qualified retirement plan, if available, you choose to distribute some or all of the employer stock in-kind to a taxable brokerage account. The distribution must occur in a lump sum, meaning that your entire employer sponsored account balance must be distributed in-kind and/or rolled over in a single tax year.

Taxation of Cost Basis: The cost basis is the original price you paid for the employer stock. When you distribute the employer stock in-kind to a brokerage account, the cost basis is subject to immediate taxation at ordinary income tax rates.

Taxation of Net Unrealized Appreciation: The NUA is the difference between the cost basis (original purchase price of the asset) and the current fair market value of the employer stock at the time of distribution. The NUA is taxed separately from the cost basis. It is subject to long-term capital gains tax rates, which are typically lower than ordinary income tax rates. Under IRS Notice 98-24, the net unrealized appreciation will alwaysbe taxed at long-term capital gains rates, regardless of the actual holding period of the stock inside the plan. However, with respect to any further appreciation in the employer securities after distribution from the plan, the holding period determines the capital gains rate that applies.

Tax Treatment upon Sale: If you sell the employer stock after the distribution, any further appreciation in value is subject to capital gains tax. However, if you hold the stock for at least one year after the distribution, it would qualify for long-term capital gains treatment, which can provide additional tax advantages.

What are the benefits?

Tax benefits: NUA can provide significant tax benefits to investors who hold highly appreciated employer stock within their 401(k) plan. If the investor takes a lump-sum distribution and rollover of their entire 401(k) balance, they can pay ordinary income tax on the cost basis of the employer stock. Once your employer stock is in a brokerage account, a subsequent sale will result in long term capital gains treatment for any appreciation that happened while the stock was in your retirement plan. By If you choose to hold the employer stock after distribution for at least one year, the additional appreciation will also be taxed at the long term capital gains rates. This can result in substantial tax savings compared to selling the stock within the 401(k) plan and paying ordinary income tax rates on the entire distribution.

Diversification: Holding a large position in a single stock can be risky. By taking advantage of NUA tax rules, investors can sell their employer stock previously held within their 401(k) plan and diversify their portfolio into other investments. The combination of tax management and risk reduction may be beneficial to your comprehensive financial plan.

Fortunately, the Internal Revenue Code allows for some flexibility in what shares you distribute in-kind and what is rolled over to an IRA, which means your advisor must conduct analysis on the cost basis and may consider cherry picking the lowest cost-basis shares for this strategy.

What are some considerations?

While NUA can offer potential tax benefits, it’s important to consider the risks and evaluate your specific financial situation. Holding a significant portion of your retirement savings in a single stock can be risky, as the value of the stock can fluctuate. Diversification and investment risk should be taken into account.

Given the complexity of NUA and its potential impact on taxes, it is advisable to consult with a financial advisor and tax professional who can assess your individual circumstances, help you understand the implications, and determine if the NUA tax rules are appropriate for your situation.

Overall, NUA can be a potentially attractive tax strategy for investors who hold highly appreciated employer stock within their 401(k) plan. However, it’s important to carefully evaluate the potential tax consequences and to understand the risks associated with holding a large position in a single stock before implementing the strategy. It’s also important to consult with a tax professional or financial advisor to determine if NUA is a suitable strategy for your individual situation.


About the author: Ashley Dickson is a co-founder and financial planner at Next Bloom Wealth LLC. She serves clients in the Kansas City area with a focus on holistic and comprehensive financial planning.

This article is intended for educational purposes only. If you’re considering this strategy, contact your financial, tax or legal advisor.

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