By: Laurie Belew
If your 401(k) retirement account includes the publicly traded stock of the company you work for, you may stand to gain significant financial and tax advantages.
The key to reaping those rewards? Understand that company stock may require a different strategy than your other assets when you rollover your 401(k). Before you do so, consider the consequences.
NUA: Do You Stand to Gain Now?
Net unrealized appreciation (NUA) is the difference between the cost basis (value) of employer stock shares when they were put into your 401(k) account and the current market value of those shares. The IRS allows for more favorable tax treatment of NUA upon distribution. This is called the NUA exception.
Here are the advantages it brings:
- Only the cost basis is taxed at the (frequently higher) income tax rate.
- NUA is taxed at the (usually much lower) capital gains rate. This could potentially save you tens of thousands of dollars or more in taxes.
- NUA is not subject to the 3.8% Medicare surtax on net investment income.
Here are the requirements for the NUA exception:
- Employer stock must be distributed in-kind. That means it must be transferred from your 401(k) to another account—such as a brokerage account—without selling or buying…
- The employer retirement plan must make a lump-sum distribution.
- The distribution must be made after a triggering event. These include death, leaving your company, reaching 59.5, the minimum age for retirement income distribution, or becoming disabled.
Or Is It Wise to Wait?
As with most financial strategies, timing is everything when it comes to NUA. There are disadvantages to distribution:
- The cost basis is subject to ordinary income tax immediately upon the stock’s sale. The sooner you sell, the more long-term tax deferral you forfeit.
- If you are under 59,5 years old, you will be subject to a 10% penalty for early withdrawal.
Numerous factors affect a decision about whether to take advantage of the NUA exception. These include your age and when you plan to retire, your tax bracket, the cost basis total, your other assets, how long you expect to hold the stock, and the financial health of your company.
To use a simplified example, the NUA exception may not make financial sense for a younger investor whose retirement account has many years of tax-deferred growth ahead.
The illustrational chart below is based on a 32% marginal income tax bracket and a 15% capital gains rate. The point at which a rollover begins to produce a more lucrative outcome than an NUA distribution is about 16 years. The financial advantage of a rollover escalates with passing years to total hundreds of thousands of dollars.
A certified financial planner can help you determine your own break-even point based on your individual circumstances and life goals. Before you decide between rollover and NUA exemption, feel free to reach out to the experts at FJY Financial.