Net Unrealized Appreciation (NUA)
Net Unrealized Appreciation or NUA is a Savings Plan stock distribution option which enables the plan participant to take possession of company shares upon or after retirement without rolling the shares over to an IRA. Electing NUA tax treatment may give investors the opportunity to convert taxable income into a long-term capital gain. This is accomplished by selecting to create NUA on the appreciated value of company stock that is in excess of what you paid for the stock.
- In order to receive NUA tax treatment on your savings plan shares you must be in a qualified plan (like a 401(k), you must take the entire balance in one tax year, and the distribution must qualify as a lump sum distribution. A distribution will qualify as a lump sum distribution if it is on account of:
- Death
- Attainment of age 591/2
- Disability
- Separation from service
- Retirement
- In order to qualify as a lump distribution the total savings plan balance must be distributed within a calendar year. Depending on your heritage, you are allowed to make either one or two distribution per year if you retire after age 55, depending on your company of origin.
- The NUA distribution strategy has three basic components:
- Average Cost Basis represents the price paid when the stock shares were purchased into the retirement plan. If pre-tax, this component is taxed as ordinary income tax rates when the shares are distributed from the plan. If tax paid, this component is not subject to taxation upon distribution.
- NUA is the difference between the average cost basis and the stock’s fair market value when the shares are distributed from your company’s retirement plan. This component is taxed at long term capital gains rates and not due until you sell the stock, unless you specifically elect to pay the tax at the time of distribution.
- Additional appreciation is the difference between the fair market value of your company shares at the time of distribution and the price you receive when you dispose of the shares. The additional appreciation will be taxed as short-term or long-term capital gains depending on how long you hold the shares after they are distributed to you from the plan.
- What happens when I take distribution of company stock and elect NUA tax treatment on the shares?
- In order to create net unrealized appreciation, you need to pay ordinary income taxes on the average cost of the shares at the time of distribution. The exception here is that if tax paid balances are involved in the transaction they are distributed tax free. At your option, you can defer all tax on the NUA portion until the shares are liquidated. When you sell shares, the net unrealized appreciation will be taxed at the long-term capital gains rate, which is currently a maximum of 15%. Any appreciation between the sale price and the distribution value will be taxed at long-term or short-term capital gains rates depending on how long the shares are held after distribution to you from the plan.
Only employer contributions and pretax employee contributions are eligible for this net unrealized appreciation tax strategy.
Summary - Normally unless you have a short-term need for capital or you are in a very high tax bracket it may make sense to avoid paying taxes today and rollover your retirement funds into an IRA. Rolling over your retirement assets into an IRA may enable you to take advantage of the benefits of tax deferred compounding. The exception is if you have savings plan shares that have a tax paid basis. Retirees should take a close look at shares that have a tax paid basis. The cost basis portion of these shares are distributed tax free and the appreciation portion is taxed at long term capital gains rates upon liquidation if they select NUA tax treatment. Shares that have a low pre-tax basis ($15 or less for example) should also be reviewed before making a final decision to rollover shares to an IRA or to receive an NUA stock distribution.
There may be some estate planning issues involving this strategy (heirs do not get the step-up in basis at death and heirs will be required to pay the capital gains tax on the NUA). It is important to carefully review your personal situation to see if this strategy would be of benefit. Associates of Krosnowski & Scott, LLC are not tax consultants. Before you employee any strategies, you should seek the services of a qualified tax professional.
- In order to create net unrealized appreciation, you need to pay ordinary income taxes on the average cost of the shares at the time of distribution. The exception here is that if tax paid balances are involved in the transaction they are distributed tax free. At your option, you can defer all tax on the NUA portion until the shares are liquidated. When you sell shares, the net unrealized appreciation will be taxed at the long-term capital gains rate, which is currently a maximum of 15%. Any appreciation between the sale price and the distribution value will be taxed at long-term or short-term capital gains rates depending on how long the shares are held after distribution to you from the plan.