Understand net unrealized appreciation (NUA) tax strategies

  • NUA relates to distributions of employer stock from an eligible employer-based retirement plan.
  • When you take a lump-sum distribution that includes employer securities, the cost basis to the plan is taxable as a distribution from the plan.
  • When sold, NUA is taxed at the long-term capital gains rate.
  • You can elect not to use the NUA tax strategy.
  • The potential tax savings of the NUA tax strategy must be weighed against the increased market risk associated in investing assets in a single stock.

Near retirement

If you have accumulated company stock in your employer-sponsored retirement plan, you may have several options when you're eligible to take a distribution from your plan. If the stock has appreciated significantly, you may want to apply the net unrealized appreciation (NUA) tax treatment.

To do this, you take an in-kind distribution of some or all of your employer securities as part of a lump sum distribution10. This does not mean everything that is taken has to be a taxable distribution. Assets other than the portion of stock you are taking in-kind can be rolled to an IRA, but there can be no assets remaining in the employer plan.11

How does NUA work?

When you take an in-kind distribution of employer stock from your retirement plan, you generally pay tax on the cost basis (original value of the stock in the plan) of the securities at ordinary income rates in the year of the distribution. A 10% penalty may apply before age 59½.2

The shares are then held in a non-qualified brokerage account and are not taxed until you sell them. Any dividends you earn are taxable when they are paid, however. When you sell the shares, you will pay taxes at the long-term capital gains rate on any remaining net unrealized appreciation and the applicable capital gains rate on any additional appreciation since distribution. The applicable capital gains rate on any additional appreciation depends on the holding period after the distribution from the retirement plan. The advantage to the strategy is the difference between the ordinary income rate and the capital gains rate on any net unrealized appreciation that exists when you sell the stock. Capital gains above the NUA amount may also be subject to a 3.8% Net Investment Income tax depending on your income.12

NUA is not for everyone and makes most sense when the stock has appreciated considerably. For many people, an IRA rollover will make more sense than taking some or all of the employer stock as an in-kind distribution. Remember that it is risky to hold a significant portion of your retirement portfolio in one stock. If your former employer goes bankrupt, you will have paid tax up front for shares of stock that become worthless.

NUA tax treatment benefits and considerations
Benefits Considerations
Direct rollover1 to an IRA — NUA tax treatment not available
  1. Income and penalty taxes not owed on the rollover amount
  2. Contributions and any earnings or dividends remain tax deferred
  3. Access to a wide variety of investment choices for asset diversification
  4. Can buy or sell shares of any security within the IRA, including any employer stock, without realizing any gains or losses9
  5. Unlimited federal bankruptcy protection
  6. Eligible for Roth IRA conversion
  1. IRA distributions are taxed at ordinary income tax rates, not capital gains tax rates (which are usually lower).
  2. May pay additional 10% tax penalty for withdrawals before age 59 ½2
  3. Subject to required minimum distributions beginning at age 70 ½
  4. Outside of bankruptcy, creditor protection is determined by state laws.3
In-kind lump-sum distribution4 of some or all of the employer securities to a brokerage account — uses NUA tax treatment (rollover the rest to an IRA)
  1. Pay long-term capital gains taxes, instead of ordinary income taxes, on any remaining NUA when the stock is sold (A tax professional can help you assess whether this makes sense for you depending on your tax bracket and expected capital gains rates.5)
  2. Required minimum distributions and IRS early withdrawal penalties do not apply to assets in a non-qualified brokerage account.
  1. Must pay ordinary income taxes on the cost basis of the stock in the plan when the shares are distributed from the employer-sponsored plan.
  2. May pay additional 10% tax penalty on the cost basis in the plan for distributions from the employer-sponsored plan prior to age 59 ½7.
  3. Must meet specific requirements to qualify for special NUA tax treatment. For example, generally only lump-sum distributions qualify for NUA tax treatment on qualifying employer securities.11
  4. Significant tax advantages may not be realized unless the stock is highly appreciated in value.
  5. May leave your retirement savings over concentrated in employer stock and therefore, vulnerable to fluctuation in the price of that stock.
  6. Dividends paid on stock will be taxable when paid.
  7. Capital gains above the NUA amount may be subject to the 3.8% tax on net investment income.12
  8. Assets generally are not protected from creditors.
Tax savings comparison

The hypothetical example below compares the tax treatment of a direct rollover and an in-kind distribution of highly appreciated employer stock. Tax savings will vary based on your personal situation. Other assets are not considered for this illustration.

This chart assumes the following at the time of distribution from the employer's plan: age 60; employer securities have cost basis in the plan of $25,000; current value of $100,000; 28% marginal ordinary income tax rate applies to the entire distribution; immediate distribution of assets with no change in share value.

      Total taxes
Direct rollover to an IRA — NUA tax treatment not available 1. Current taxes due upon rollover from employer's plan $0 $28,000
2. Penalty taxes due upon rollover from employer's plan $0
3. Current taxes due6 upon distribution of cash from the IRA (assumes all shares have not changed in value) $28,000
In-kind distribution to a brokerage account — utilizes NUA tax treatment 1. Current taxes due on the cost basis in the plan upon distribution from employer's plan $7,000 $18,250
2. Current taxes due8 upon sale of stock from the brokerage account (assumes no dividends were paid, all shares have not changed in value and are sold and taxed at 15% rate5 ) $11,250
Potential tax savings due to NUA tax treatment $9,750

This is a highly simplified hypothetical example; it is very important to consult your tax advisor before taking any action.

As you consider NUA tax treatments for your distributions, keep in mind that they can be complex. An Ameriprise financial advisor, together with a tax professional and your plan administrator, can help you navigate federal and state tax implications.

1 To be considered a direct rollover and avoid having 20% withheld from your distribution to prepay taxes, a check must be sent directly from your former employer to your IRA or a check must be made out to the IRA custodian.

2Certain exceptions to the 10% penalty may apply.

3 Federal bankruptcy protection afforded under the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005.

4 For an in-kind distribution, shares of the employer security are transferred from the employer plan to your brokerage account.

5For 2014, long term capital gains are taxed at 0% for gains in 10% and 15% tax brackets; 15% for gains in 25-35% brackets; and 20% for those in the 39.6% bracket.

6 Any available NUA tax treatment is irrevocably forfeited when employer securities are rolled over. Current taxes, at ordinary income tax rates, are generally due on all amounts (other than after-tax contributions and other basis) distributed from an IRA.

7 Penalty taxes don't apply on distributions made after age 59½ (and with certain criteria after age 55 and other limited exceptions).

8 When shares are sold, long-term capital gains taxes (assumes 15%) are due on the remaining NUA (value upon distribution from the employer plan minus cost basis to the plan).

9 Many IRAs only permit publicly traded securities to be held.

10 For purposes of the tax treatment of net unrealized appreciation in employer securities distributed as part of a lump-sum distribution, a "lump-sum" distribution" is a distribution or payment: within one tax year of the recipient; of the balance to the credit of an employee; from a Code Sec. 401(a) qualified plan exempt from tax under Code Sec. 501(a), or code 403(a) annuity; which death; 2) after the employee reaches age 59½; 3) on account of a common law employee's separation of service, or; 4) after a self-employed individual has become disabled (as defined in Code Sec. 72 (m)(7) of the annuity rules. There are many other rules surrounding when a distribution constitutes a lump-sum distribution. See your tax advisor.

11 Individuals who have made nondeductible employee contributions may receive net unrealized appreciation on securities attributable to those contributions without a lump-sum distribution.

12 The 3.8% tax on net investment income applies to the lesser of Net Investment Income or Modified Adjusted Gross Income over $200,000 for single filers and $250,000 for married filing jointly. It does not apply to NUA or distributions from an IRA or qualified retirement plan.

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