Can You Take Advantage of a Net Unrealized Appreciation (NUA) Strategy?

Many companies offer employer-issued stock as a benefit, in addition to other compensation and benefits. But what happens if you leave a job that offered you employer-issued stock or if you experience another triggering life event (such as turning 59½)?

That's where net unrealized appreciation (NUA) strategies come in. There are a few favorable rules to help you determine what to do with those company stocks to potentially minimize your tax bill.

Let's look at what NUA is, how NUA rules work, and some of the potential benefits of an NUA strategy.

What is Net Unrealized Appreciation (NUA)?

Some companies offer the benefit of employees owning stock in the employer company. The idea is that this creates an ownership mentality in the employees, even if they own a very small percentage of total shares.  NUA is the difference between how much you paid or contributed to your company stock and its present market value. For example, if you were issued employer stock at $20 per share and it is now worth $40 per share, you would have an NUA of $20 per share ($40 - $20 = $20).  The NUA can be a very important factor to consider if you are distributing highly appreciated employer stock from your tax-deferred employer-sponsored retirement plan, such as a 401(k).

What are the NUA Rules?

NUA is taxed differently than other payments. According to the IRS, "If the lump-sum distribution includes employer securities, the NUA is generally not subject to tax until you sell the securities."¹

With this rule from the IRS in mind, a participant may be able to transfer company stock from their previous plan into a taxable investment account without having to treat the entire amount as ordinary income. Instead, they would only have to treat the original amount they paid as ordinary income, which could potentially save them money on taxes.

This strategy can be used when taking distributions out of an original account due to a triggering life event, such as retiring or changing jobs.

The Benefits of an NUA Strategy

The main benefits of utilizing an NUA strategy are tax-related. Because you are only taxed on your contribution amount and not any unrealized gains, you may be able to avoid taxation now and receive favorable long-term capital gains taxes later.

According to the IRS, "The tax rate on most net capital gain is no higher than 15% for most individuals. Some or all net capital gain may be taxed at 0% if your taxable income is less than or equal to $40,400 for single or $80,800 for married filing jointly or qualifying widow(er)." As you can see, implementing an NUA strategy by rolling your employer stock into a taxable investment account can pay off both in the short term and in the long term.²

Who Benefits?

Clients might be interested in the NUA strategy if they:

• Have separated from the service of an employer (or are otherwise eligible to take a lump-sum distribution of their account).
• Own highly appreciated employer stock in an employer-sponsored retirement plan.
• Expect to be in a high tax bracket when they sell the company stock for income.

How do they benefit?

• May help clients reduce their taxes on the income from the sale of employer stock.
• May reduce clients' future minimum required distributions (MRDs), since the employer stock is held outside an IRA.
• Offers the possibility of passing favorable tax treatment on to beneficiaries.

You may want to consider additional factors such as a client's tax bracket, age when separated from service, and overall retirement assets before discussing the NUA strategy with your financial advisor. Clients should understand the risks inherent in investing in company stock. Future depreciation may offset the tax benefits of the NUA strategy.

It is also important to talk to your financial advisor before implementing an NUA strategy because, in addition to these benefits, there are also some key considerations and requirements. You must meet special requirements to take full advantage of an NUA strategy but consider the following:

1. You must receive the stock as a lump-sum, in-kind distribution and then transfer the stock itself into your investment account.
2. Within one year, you must distribute the entirety of the vested balance held in the plan, including all assets from all of the accounts sponsored by the same employer.
3.  You must have either separated from the company, reached the minimum retirement age for distribution, suffered an injury resulting in total disability, or you must have died.

There are a few other details to consider, so it's best to work with a financial professional to make sure no details are forgotten.  If you are considering changing jobs or feel that you may have stock options that have NUA, please contact us so that we can help you make the best financial decision.