Net Unrealized Appreciation
If you participate in a 401(k), ESOP, or other qualified retirement plan that includes ownership in your employer's stock, you need to know about net unrealized appreciation.
When you make a withdrawal from your employer’s retirement plan, the distribution is generally taxable to you at ordinary income tax rates. Many choose to rollover their holdings tax-free from the retirement plan to their IRA, where the distribution is ultimately also taxable to you at ordinary income tax rates (special rules apply to Roth and other after-tax contributions).
But if the distribution from your employer’s retirement plan includes employer stock, you may be able to utilize a little known section of the IRS code that allows you to defer paying tax on the portion of your distribution that represents net unrealized appreciation (NUA). You won't be taxed on the NUA until you sell the stock, when you’ll be taxed at long-term capital gains rates that are typically much lower.
A distribution of employer stock consists of two parts: (1) the cost basis (which is the value of the stock when it was contributed to, or purchased in, your plan) and (2) any increase in value over the cost basis until the date the stock is distributed to you. This increase in value over basis, fixed at the time the stock is distributed in-kind to you, is the NUA.
For example, assume you retire and receive a distribution of employer stock worth $500,000 from a 401(k) plan, and that the cost basis in the stock is $50,000. The $450,000 gain is NUA.
By taking the stock distribution, you'll pay ordinary income tax only on the cost basis in the employer securities. You won't pay any tax on the NUA until you sell the securities. At that time the NUA is taxed at long-term capital gain rates, no matter how long you've held the securities outside of the plan. Any gain above the NUA is taxed at sale as either short-term or long-term capital gain, depending on how long you've held the stock outside the plan.
You must take the employer stock distribution directly from the retirement plan – the NUA is not available once the stock has been rolled over to another plan, an IRA for instance.
There are additional rules and both advantages and disadvantages that apply to the NUA strategy. It should be viewed as a potential strategy with your other income and assets. It can be a great strategy for those who qualify!
Mike
Mike Mickels is the President and Chief Compliance Officer of CochranMickels Retirement Specialists, LLC and an avid sporting clay competitor. CochranMickels Retirement Specialists provides personalized planning and investment services to individuals approaching and in retirement. CochranMickels Retirement Specialists, LLC is a registered investment adviser. This platform is solely for informational purposes. Advisory services are only offered to clients or prospective clients where CochranMickels Retirement Specialists, LLC and its representatives are properly licensed or exempt from licensure. Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital. As a registered investment advisory firm, we are restricted from posting, publishing or otherwise disclosing any form of testimonial which is related to our investment advisory services. Links to websites and other resources operated by third parties are provided as information only, and there can be no assurance as to its accuracy, suitability or completeness. CochranMickels Retirement Specialists, LLC does not endorse, authorize or sponsor the content or its respective sponsors and is in no way responsible for third party content, services, products or information, or for the collection or use of information regarding the web site’s users and/or members.