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.
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 net unrealized appreciation and the applicable capital gains rate on any remaining appreciation. The applicable capital gains rate on any remaining 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 may also be subject to a 3.8% Medicare surtax 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
|Direct rollover1 to an IRA — NUA tax treatment not available||
|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)||
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; 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.
|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, the client is not subject to the 3.8% Medicare surtax and 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.
5Beginning in 2013, long term capital gains are taxed at 0% for taxpayers in 10% and 15% tax brackets; 15% for taxpayers 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 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 is payable either: 1) on account of the employee's 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.
12The 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 filersand $250,000 for married fililng jointly. It does not apply to distributions from an IRA or qualified retirement plan.
This information is not intended as legal or tax advice. Please consult with your legal and tax advisors regarding your individual situation.
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Ameriprise Financial Services Inc. and its affiliates do not offer tax or legal advice. Consumers should consult with their tax advisor or attorney regarding their specific situation.