A Tax Saving Rollover Option for Your Company Stock
Retirement plan trigger events (death, disability, separation from service, or reaching age 59 ½) come with an opportunity. If you have company stock in an employer-qualified retirement plan, you may have an opportunity to elect net unrealized appreciation (NUA), allowing you to roll your company stock into a taxable account for potential tax savings.
Potential Tax Savings with NUA
Electing NUA is trading ordinary income tax rates for capital gain tax rates.
When an NUA election is made, only your cost basis (the amount you paid for the stock) is taxed at ordinary income tax rates rather than the entire value of the stock. Once the stock is in a taxable account, the stock’s gain is taxed at preferential capital gain tax rates when sold. The stock does not have to be sold right away so you can defer the sale of the stock (and taxes) if you choose.
To elect NUA, there are certain requirements that must be met:
- A triggering event must have occurred. A triggering event is death, disability, separation from service, or reaching age 59 ½. The entire plan balance must be taken in a lump sum distribution within the tax year of a triggering event. This means, if NUA is elected, money cannot stay in the employer plan past the end of the year. However, the rest of account could be rolled to an IRA, still allowing a portion of the company stock to be elected as NUA.
- Stock must be transferred in-kind. This means you cannot liquidate the shares before transferring and then repurchase the stock in a taxable account.
If the above requirements can be met, evaluate if NUA is a good strategy for you. This is largely dependent on your basis in the stock. An NUA strategy usually works best if you have relatively low cost basis in a company stock with large gain.
An Example of NUA Tax Savings
Let’s say you have $50,000 in employer stock with a basis of $10,000, and you are in the 25% tax bracket.
- With an NUA election, you would pay $2,500 ordinary income tax on the $10,000 basis ($10,000 * 25%) when transferring the stock to a taxable account. Subsequently, you sell the employer stock and pay $6,000 in capital gain taxes (Gain of $40,000 *15% capital gain rate). Your total tax paid is $8,500.
- Without an NUA election, the entire $50,000 would be taxed at your ordinary tax rate of 25%. You would pay $12,500 in taxes ($50,000 * 25%).
In this example, NUA saves $4,000 in taxes.
Not Ideal For Everyone
While NUA can be attractive, it may not always be the best option. If your basis in the company stock is high, the appeal for electing NUA decreases.
Using the example above but with a basis of $45,000, the taxes paid for electing NUA would be $11,250 ($45,000 * 25%) and the sale of the stock would result in additional $750 (Gain of $5,000 * 15% capital gain rate). This would result in a $12,000 tax bill compared to paying $12,500 in taxes if you did not elect NUA. The tax is still a bit less than allowing the entire stock value to be taxed at ordinary tax rates; however, if there is no immediate need for the money, you just gave up the tax deferral of an IRA for a taxable investment account.
Is NUA Right For Me?
To determine if NUA makes sense for you, consult with a financial advisor. An advisor can help you decide if this strategy makes sense for you by comparing the long-term effects of keeping the company stock in a tax-deferred IRA against the NUA option of paying taxes on your cost basis now and paying capital gain tax rates in the future.
Sources: https://www.kitces.com/blog/net-unrealized-appreciation-irs-rules-nua-from-401k-and-esop-plans/, https://www.goodfinancialcents.com/net-unrealized-appreciation/, and https://www.key.com/pdf/unrealized-appreciation.pdf
This information is intended for informational purposes only and should not be construed as personalized investment or tax advice. Please consult your investment and tax professionals regarding your specific circumstances.