When you retire, or when you leave a company, there is a unique tax break called Net Unrealized Appreciation (NUA), available for company stock held in a pretax company retirement plan. You are allowed to move the company stock in-kind, to a non-IRA brokerage account, instead of rolling it over to an IRA. This allows you to continue deferring tax on all the growth of that stock that occurred while in the company plan, until it is sold.
What's more, when you sell the stock, this growth, which is called net unrealized appreciation, will be taxed at the more favorable long-term capital gain tax rates, which are lower than the ordinary income tax rates you normally pay on withdrawals from company retirement plans or IRAs. This strategy can result in significant tax savings.
Keep in mind the original amount you paid for the stock inside your company plan will become taxable immediately as ordinary income, and a 10% early payment penalty tax may be incurred if you're not 55 or older when you withdraw the company stock. However, if the majority of the stock’s value is from appreciation, NUA can be a great tax saver.
To qualify for the special tax treatment, certain guidelines must be met:
You must do a lump-sum distribution of your entire 401k account balance within the calendar year taken - because of either separation from service, death, or disability, or if you’ve reached age 59 1/2. This means your end of year 401k account balance must read zero! Also, the company stock must be distributed in kind from the retirement plan. The NUA rule does not apply if the stock is liquidated in the plan and distributed in cash or rolled over to an IRA. It is important to note that once the stock is rolled over to an IRA, the opportunity to use the NUA rule is lost.
Let’s say you retire from ABC Company and you receive a $300,000 distribution of ABC stock from your 401k plan, and you have the rest of it rolled over to an IRA. Also let’s assume you’re in a 32% tax bracket. If the cost basis in the stock is $50,000, then the NUA is $250,000.
When you withdraw the company stock, you pay ordinary income tax on the $50,000 cost basis at your marginal bracket, which is 32%. So it would cost you 32% of the $50,000 or $16,000. But you won’t pay any tax on the $250,000 of NUA until you sell the stock.
In the future when you sell it, the NUA is taxed at the more favorable long-term capital gain tax rate of 15% instead of 32%, no matter how long you’ve held the securities outside of the plan (even if only for a single day). In this example, you just cut your tax more than in ½! Wow!!
The content is developed from sources believed to be providing accurate information. The information in this material is not intended as tax or legal advice. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information and should not be considered a solicitation for the purchase or sale of any security.