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Net unrealized appreciation (NUA) is the difference between the cost basis and the current market value of shares of employer stock held in an employer-sponsored retirement account.
If certain criteria are met (death, disability, separation from service, or reaching age 59 ½) an investor can transfer everything in their 401(k) to a rollover IRA—except their employer’s stock. These shares, instead, get deposited into a regular taxable brokerage account.
This triggers an immediate income tax bill on the stock’s cost basis (at income tax rates), which is the amount you paid for the stock when you received it as a matching employer contribution.
But in return for paying that tax bill, you get a tax break: All of the appreciation in the stock’s value is potentially taxable at the long-term capital gains rate. This can be advantageous because retirement account withdrawals are usually taxed at the higher income tax rate.
When I worked for ExxonMobil (XOM), after the pension lump sum payment option, this was the most discussed topic amongst soon to be retirees. And to me, it seemed quite understandable, as who wouldn’t want to pay 15% capital gains tax instead of 24% (or higher) income tax?
Well all that changed when I attempted to execute a NUA myself. First I contacted PlanVision to conduct a cold eyes review of my finances as well as specifically asking them to provide a NUA analysis.
-The article also mentions that there is an upfront tax benefit of NUAing shares (vs keeping the shares in a 401k/IRA), but that it fades over time (due to the tax on dividends).
-It also notes that if the stock in question pays no or very low dividends then a NUA becomes more attractive. BTW: I was never a fan of dividends.
I of course did what I always do when faced with a moral, philosophic, or economic dilemma . . . I created a spreadsheet, which I then played around with by changing the various inputs (years, rate of returns, tax rates). It confirmed what I had read and helped me better understand the issue. I was also able to enter the exact parameters I am facing.
Bottom Line:
If you’ve ever conducted a NUA, I’d appreciate any details and insight.
Thanks Mike for great coverage of a complex topic that I’ve thought about as well. I knew it only made sense for shares that were substantially below the current price, but I hadn’t thought about the ongoing effect of taxes on dividends.
Your article reinforces my gut feeling that it’s sufficiently complicated, the shares I could apply it to sufficiently few, and tax on future dividends sufficiently significant, that if I just stop thinking about preserving the potential for NUA it probably won’t make much difference.
If I were to ditch the 401k, I’d take a closer look at other income that year to see if it made sense. Otherwise I may just park it in the “not worth the headache” file.
I agree the Kitces article you link to is a great comprehensive essay regarding the elective taxation treatment of net unrealized appreciation (NUA) of employer stock when distributed.
I also like the article about NUAs in Investopedia titled Rolling Over Company Stock From a 401(k): When It Does—and Doesn’t—Make Sense –
https://www.investopedia.com/investing/rolling-over-company-stock/
My past experience with NUAs consists of preparing individual tax returns for people who had done a NUA.
Observing the warnings in the Kitces and Investopedia articles are critical to get the tax results you are looking for and a failure to meet all of the IRS requirements in a NUA distribution could result in a huge additional tax liability.
I would add to the articles comments that if you have a large capital loss carryforward that you may be able to offset any such capital loss carryforward with some or all of the capital gain you realize when you eventually sell the appreciated in kind stock you receive in a NUA distribution.
The section titled Tips on Taking Advantage of NUA in the Investopedia article seem to be good additional considerations in your planning. Like everything else in taxes, NUA tax laws could change. You may want to check to be sure the laws have not changed before taking action.
I hope this helps.
Are you sure about the stock rollover? I’m not an expert on this, but what I read says you can rollover employer stock from a 401k into a IRA.
R Quinn, You are correct that you can rollover employer stock from a 401k into an IRA, though how would this affect my decision?
My understanding is you can rollover employer stock to an IRA, but if you do you lose the opportunity to use NUA. Once rolled over to an IRA it is ordinary income when distributed, and subject to RMDs.