Employers often reward employees with shares of company stock through bonuses, deferred compensation, or matching retirement plan contributions. It is quite common for long-term employees to accumulate a significant balance in their company’s stock.
Net Unrealized Appreciation (NUA) is a tax strategy that allows investors to potentially lower the tax burden on the distribution of company stock from their employer-sponsored retirement plans, such as a 401(k) or Employee Stock Ownership Plan. When an individual receives a distribution of company stock, the NUA is the difference between the cost basis (the original price paid for the stock) and its market value at the time of distribution.
Let’s say you have accumulated 1,000 shares of your company’s stock in your 401(k) plan. The stock was acquired with an average cost basis of $25 per share, making the total cost basis $25,000. At the time of distribution, the stock is valued at $300 per share, resulting in a total market value of $300,000. The NUA is $275 per share or $275,000 for the 1,000 shares.
To qualify for the NUA tax treatment, you must distribute all assets from all qualified plans with your employer in a single tax year. The distribution must be actual shares of the company stock, and you must be either separating from the company, age 59 ½, or totally disabled. The non-company stock assets in your plan can be rolled into an IRA to continue growing on a tax-deferred basis.
When you leave your job or retire and your retirement account includes company stock, you can transfer the stock to a taxable brokerage account—a taxable event; however, you will only pay ordinary income tax on the cost basis of the stock. When you eventually sell the stock, the NUA portion is taxed at the long-term capital gains rate, which is generally lower than the ordinary income tax rate. Ordinary income tax rates can be as high as 37% for high-income earners, whereas long-term capital gains tax rates are typically 0%, 15%, or 20%, depending on your income level. By utilizing the NUA strategy, you can take advantage of these lower capital gains tax rates on the appreciation of your company stock.
The NUA strategy may be beneficial during the “income gap” years, such as the time between retirement and when you begin Social Security or pension benefits or drawing upon your tax-deferred accounts. However, owning significant amounts of one company’s stock can leave you needing diversification. If the appreciated stock makes up more than 10% of your total portfolio, you may want to consider rolling the stock into an IRA, selling the stock, and diversifying the portfolio, with no tax consequences until you start taking distributions are taken from the IRA.
Net Unrealized Appreciation offers a compelling tax strategy if you have significant company stock holdings in your retirement plans. Professional advice is highly recommended because of the complexity and risks involved, and to ensure the strategy aligns with your overall financial goals and circumstances.
If you have questions on how to manage company stock upon retirement, the experts at Henssler Financial will be glad to help:
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- Email: experts@henssler.com
- Phone: 770-429-9166
Listen to the July 13, 2024 “Henssler Money Talks” episode.
This article is for demonstrative and academic purposes and is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
