Net Unrealized Appreciation: What you don’t know CAN cost you!

| May 15, 2015

Mike's Blog

If you’re in a retirement plan (like a 401k) that lets you invest in your company’s stock, you should be aware of something called net unrealized appreciation or NUA, a simple tax reduction strategy with a complicated name.

When you withdraw your employer's retirement plan (like a 401k plan for example), it’s fully taxable unless you roll it over to an IRA - which is the preferred method, unless you feel patriotic and want to pay unnecessary taxes! Believe me, the government can sure use the revenue!

The thing is, down the road at some point you’ll take income from that IRA. At that point the income you take will be taxed as ordinary income at your top marginal tax bracket.

Now let’s back up a couple steps. Say your retirement plan has company common stock in it. If so, there may be another option. You may have a shot at paying long term capital gains rates on a portion of that common stock instead of ordinary income taxes. Why does it matter? Because the top marginal tax rate is 39.6%, the top LTCG rate is 20%. Which would you rather pay?! This can be HUGE for some of you out there!

Here’s generally how it works: you remove the common stock from the employer plan (I didn’t say sell it, I said remove or withdraw it). Also, do not roll the common stock to an IRA. Note: If there is still a balance left in your company retirement plan after you withdraw the company stock, you should roll that part to an IRA.

What is net unrealized appreciation?

First, at this point the common stock has been withdrawn from the employer plan and is NOT in an IRA.

Now there’s two parts to NUA: (1) the cost basis, this is the amount originally put into the stock (2) the growth over the cost basis up to the date the stock is withdrawn. Let’s say you retire from Abbott Labs and you receive a $500,000 distribution of Abbot stock from your 401(k) plan. If the cost basis in the stock is $50,000, then the NUA is a $450,000.

When you withdraw the company stock, you pay ordinary income tax on the $50,000 cost basis only at your marginal bracket. You won't pay any tax on the $450,000 NUA until you sell the stock. See how this works?!

In the future when you sell it, the NUA is taxed at the more favorable long-term capital gain tax rates, no matter how long you've held the securities outside of the plan (even if only for a single day). Any appreciation at the time of sale in excess of your NUA is taxed as either short-term or long-term capital gain, depending on how long you've held the stock outside the plan.

Warning: if IRS rules are not followed precisely, this whole strategy will get a wrench thrown in the engine. Also, if tried at too early an age, there may be a 10% early withdrawal penalty. If you have questions on NUA or anything thing else, contact us for more information.

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.