If company stock is offered to you through a 401(k) or other workplace retirement plan, it can be a great opportunity for you to have a stake in the business. Plus, if you accumulate employer stock within a qualified employer retirement plan over many years, that stock may appreciate considerably.
However, when the time comes to take distributions out of the account, perhaps because you’re retiring or switching jobs, there are important tax implications to consider.
If you take cash distributions out of the retirement account, you’ll have to pay ordinary income tax. But, if you are able to take advantage of the little-known IRS “Net Unrealized Appreciation” (NUA) rules, you’ll have more control of those distributions and how and when these distributions are taxed.
What is NUA?
NUA, or Net Unrealized Appreciation, is the difference between the original cost (contribution) of employer stock and its present market value. If you subtract what you paid for the stock over time (your contribution) from what the stock is worth in today’s dollars, the balance is your NUA.
How do the NUA rules work?
NUA rules are special exceptions that enable the participant in an employer retirement plan to transfer the stock from that plan into a taxable investment account without having the entire distributed amount treated as ordinary income. Instead, only the amount you contributed would be immediately considered as ordinary income in the same way that any tax-deferred wages into a retirement plan would be taxed when they are eventually distributed to a taxable account.
What’s the benefit?
The advantage is that, under the NUA rules, the unrealized appreciation portion (market value minus cost) of employer stock can avoid taxation now and will receive favorable long-term capital gains tax treatment once the employer stock is sold. You can take advantage of this long-term capital gains treatment no matter how long the stock was actually held in the plan. And, even if the company stock appreciates once it’s in the taxable account, it will continue to receive long-term capital gains tax treatment.
Here’s an additional consideration. Typically, capital gains are considered investment income for purposes of the net investment income tax. However, capital gains resulting from NUA gain are not considered investment income and are not subject to the 3.8% Medicare surtax. In other words, taking advantage of NUA rules could help you see tax savings.
Are there any limitations to taking advantage of NUA rules?
There are. Special requirements must be met for you to take full advantage of NUA tax treatment on company stock. You will need to receive the stock as a lump-sum, in-kind distribution in accordance with a “triggering event.” Triggering events include death, disability, separation of service from employment, or reaching age 59½,
You will then have to transfer the employer stock itself – not the cash proceeds – from the employer retirement plan into a taxable investment account and the entire plan balance must be distributed all in the same tax year.
If there is any partial distribution during the year, the remainder of all qualified retirement accounts with that employer need to be distributed by the end of that year. Additionally, a triggering event must precede the distribution for it to be eligible for NUA treatment. If one of those triggering events does not occur, if the appropriate accounts are not emptied in the same tax year, or if the stock is not transferred in-kind, NUA treatment is lost, and the entire distribution will be taxed as ordinary income.
Can I transfer my company stock from my qualified plan into another 401(k) or IRA and take advantage of NUA rules later?
No. NUA treatment is only available when the stocks are transferred out of the original employer’s qualified plan. NUA is also not an “all-or-nothing” proposition. While all assets must leave the employer qualified plans to take advantage of NUA, you can pick and choose which shares you want to qualify for NUA. Any stock not used for NUA can be distributed outright or rolled into an IRA or into your new employer’s 401(k).
How do I know if the NUA rules make sense for me?
It’s a good question. Whether or not the NUA rules will benefit you will depend on multiple factors, including your income, your retirement goals, and more. We recommend that before you consider taking advantage of NUA rules, you sit down with your financial adviser for a thorough evaluation of your portfolio and your needs.
Your Modera team is here to help you understand even the most complex intricacies of financial management and will work to help guide you to the solutions that we believe are the most beneficial to you. If you’d like to know more about NUA, or have any other questions, please get in touch.
Modera Wealth Management., LLC is an SEC registered investment adviser with places of business in Massachusetts, New Jersey, Georgia, North Carolina and Florida. SEC registration does not imply any level of skill or training. Modera may only transact business in those states in which it is registered or qualifies for an exemption or exclusion from registration requirements.
For additional information about Modera, including its registration status, fees and services and/or a copy of our Form ADV Disclosure Brochure, please contact us or refer to the Investment Adviser Public Disclosure web site (www.adviserinfo.sec.gov). A full description of the firm’s business operations and service offerings is contained in our Disclosure Brochure which appears as Part 2A of Form ADV. Please read the Disclosure Brochure carefully before you invest or send money.
This article is limited to the dissemination of general information about Modera’s investment advisory and financial planning services that is not suitable for everyone. The case study represented here is hypothetical in nature and is used for illustrative purposes only. It should not be construed as a testimonial. Each client’s situation and circumstances are different, and the foregoing should not be relied upon as legal or financial advice for one’s individual circumstances. Nothing herein should be interpreted or construed as investment advice nor as legal, tax or accounting advice nor as personalized financial planning, tax planning or wealth management advice. For legal, tax and accounting-related matters, we recommend you seek the advice of a qualified attorney or accountant. This article is not a substitute for personalized investment or financial planning from Modera. There is no guarantee that the views and opinions expressed herein will come to pass, and the information herein should not be considered a solicitation to engage in a particular investment or financial planning strategy. The statements and opinions expressed in this article are subject to change without notice based on changes in the law and other conditions.