NUA Tax Strategy

GOT COMPANY STOCK in your 401(k) plan? If you leave your employer, consider taking advantage of the net unrealized appreciation, or NUA, tax strategy. The idea is to transfer everything in your 401(k) to a rollover IRA—except your 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, which is the amount you paid for the stock or the amount it was worth when you received it as a matching employer contribution. (This tax bill can be sidestepped if you contributed after-tax dollars to the 401(k) equal to the stock’s cost basis.) If you are under age 59½, you will likely also have to pay a 10% tax penalty on the stock’s cost basis.

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 is advantageous, because retirement account withdrawals are usually taxed at the higher income tax rate, though this advantage has been somewhat reduced by the lower income tax rates introduced by 2017’s tax law.

While the stock’s appreciation within the 401(k) will be taxed at the long-term capital gains rate, the subsequent appreciation—after you pull the stock out of the 401(k)—will only be taxed at the capital gains rate if you wait a year before selling.

The NUA strategy makes most sense if the stock has greatly appreciated in value. What if the shares haven’t climbed that much? You may want to continue deferring taxes—and avoid the immediate income tax bill and possible tax penalty—by transferring everything, including the stock, to an IRA.

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