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Understand net unrealized appreciation (NUA) tax strategies

Key Points

  • NUA is a special tax treatment that relates to distributions of appreciated employer securities from an eligible employer-based retirement plan as a part of a qualifying lump-sum distribution.
  • The taxation of the securities is based on the cost basis of the securities and the amount that they have appreciated while in the plan.
  • The cost basis of the securities that are distributed in-kind will be taxed at ordinary income tax rates when you take a qualifying lump-sum distribution that includes appreciated employer securities. It will be taxed in the year you take the distribution from the plan. A 10% premature distribution penalty may apply.1
  • Taxation of the appreciation, the NUA, following a lump-sum distribution is deferred until the employer securities are sold or disposed of.
  • When securities are sold, any NUA is taxed at the long-term capital gains rate. Any additional gain is taxed based on the holding period of the securities after they are distributed.
  • 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 security while in the plan or upon distribution if the securities are not sold immediately.
  • NUA is not available and is irrevocably forfeited if the employer securities are rolled into an IRA.2

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

To do this, you would take an in-kind distribution of some or all of your employer securities as part of a lump sum distribution. For purposes of the tax treatment of NUA in employer securities distributed as part of a lump-sum distribution, a lump-sum distribution is a distribution or payment:

  • Within one taxable year of the recipient,
  • Of the balance to the credit of an employee,
  • From a qualified pension, profit-sharing or stock bonus plan, payable to the recipient
    • on account of the employee’s death;
    • after the employee reaches age 59½;
    • on account of the employee's separation from service, or;
    • after a self-employed individual has become disabled (as defined in Code Sec. 72 (m)(7) of the Internal Revenue Code).

The rules surrounding when a distribution constitutes a lump-sum distribution are complex, for example, certain types of plans must be aggregated for this to work. See your tax adviser for more information. Assets other than the portion of securities you are taking in-kind can be rolled to an IRA. The balance to the credit includes all amounts in the account, including nondeductible employee contributions, as of the first distribution received after the triggering event, for the most part there can be no assets belonging to the employee remaining in the employer plan. A tax adviser working with the plan's administrator, can help determine if the distributions qualify as a lump-sum distribution.3

 

How does NUA work?

When you take an in-kind distribution of employer securities from your retirement plan as part of a lump-sum distribution, you generally pay tax on the cost basis4 (the trust’s cost basis for the security) of the securities at ordinary income rates in the year of the distribution. A 10% penalty may apply before age 59½.1

The employer securities are then held in a nonqualified brokerage account and any gains, either while the securities were in plan or after the securities were distributed from the plan, are not taxed until you sell them. Any dividends you earn are taxable when they are paid and can be eligible for special tax rates that apply for qualified dividend income. When you sell the securities, you will pay taxes at the long-term capital gains rate on any NUA and the applicable short or long-term 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 tax rate (if the securities were sold and cash was distributed either from the plan or IRA) and the potentially lower long-term capital gains tax rate on any NUA (and any post-distribution long-term capital gain) that exists when you sell the securities.

NUA is not for everyone and makes most sense when the security has appreciated considerably in the plan. For many people without an immediate cash need, leaving assets in the plan or an IRA rollover may make more sense than taking some or all of the employer securities as an in-kind distribution. Remember that it is risky to hold a significant portion of your retirement portfolio in one security. A tax adviser can perform calculations to see which options could work from a tax perspective. Note: You are not required to take al of the employer securities in-kind. You can take some in-kind and rollover the rest and still qualify for NUA treatment on the in-kind amounts, provided you meet all of the requirements.

 

NUA tax treatment benefits and considerations comparison

Benefits Considerations
Direct rollover5 to an IRA — NUA tax treatment no longer available
  1. Income taxes and the potential 10% early withdrawal penalty taxes are not owed on the rollover amount.
  1. IRA distributions are taxed at ordinary income tax rates, not long-term capital gains tax rates (special lower rates currently apply to long-term capital gains and qualified dividend income).6
  1. The amount rolled over, subsequent contributions, and any earnings or dividends remain in the IRA plan tax-deferred.
  1. May pay additional 10% tax penalty for withdrawals before age 59 ½.7
  1. Access to a wide variety of investment choices for asset diversification.
  1. Subject to required minimum distribution rules.
  1. Can buy or sell shares of any security within the IRA, including any employer stock, without realizing taxable gains or losses.8
  1. Outside of bankruptcy, creditor protection is determined by state laws.
  1. Unlimited federal bankruptcy protection.9
  1. Fees may be higher in an IRA.
  1. Eligible for Roth IRA conversion.
  
In-kind10 lump-sum distribution11 of some or all of the employer securities to a taxable brokerage account — uses NUA tax treatment (may roll over the rest to an IRA)
  1. Pay long-term capital gains taxes, instead of ordinary income taxes, on any NUA when the securities are sold. This may be particularly useful for individuals who have an immediate cash need (a tax professional can help you assess whether this makes long-term sense for you depending on your current and future tax brackets and expected capital gains rates).12
  1. Must pay ordinary income taxes on the cost basis of the securities in the plan when they are distributed from the employer-sponsored plan.4
  1. Required minimum distribution rules do not apply to the securities that are distributed.
  1. May pay additional 10% tax penalty on the cost basis in the plan for distributions from the employer-sponsored plan prior to age 59½, unless an exception applies.1
  1. IRS early withdrawal penalties not applicable to the NUA portion of the distribution.1
  1. Must meet specific requirements to qualify for special NUA tax treatment. For example, generally only lump-sum distributions4,11 qualify for NUA tax treatment on qualifying employer securities.
  1. Dividends paid on stock can be taxed at a special long-term capital gain rate when paid.
  1. Significant tax advantages may not be realized unless the securities are highly appreciated in value.

 
  1. May leave your retirement savings over-concentrated in employer stock and therefore, vulnerable to fluctuation in the price of that stock.

 
  1. Assets in non-qualified accounts generally are not protected from creditors.

5. NUA is not subject to the 3.8% net investment income tax (NIIT).
  1. Capital gains above the NUA amount may be subject to the 3.8% tax on net investment income.13
 

8. There is no step up in basis on NUA. Your beneficiaries may need to pay tax at long term capital gains rates on the NUA when they sell the stock.

 

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 when a 50-year-old employee takes a lump-sum distribution upon separation from service, any remaining assets are rolled into an IRA. Tax savings will vary based on your personal situation. Other assets are not considered for this illustration. Example is for employer stock worth $100,000 with a cost basis of $25,000. All of the ordinary income in the example is in the 32% federal income tax bracket.

Direct rollover5 to an IRA (NUA tax treatment does not apply) In-kind distribution to a taxable brokerage account (using NUA tax treatment)
  • Current taxes due upon rollover from employer’s plan: $0
  • Current taxes due on the cost basis in the plan upon distributing employer stock from employer’s plan: $8,000 ($25,000 * 32%)
  • Penalty taxes due upon rollover from employer’s plan to IRA: $0
  • Penalty taxes1 due on the cost basis in the plan upon distributing employer stock from the employer’s plan: $2,500 ($25,000 * 10%) (This amount would not be due for people age 59 ½ or those who otherwise qualify for an exception to the 10% penalty)
  • Federal taxes due2 upon withdrawal of cash from the IRA: $32,000 (100,000 * 32%)
  • Current taxes14 due upon sale of stock from the brokerage account: $11,250 ($75,000 * 15%)
  • Penalty taxes7 due if withdrawn from the IRA prior to 59 ½: $10,000 (100,000 * 10%)
  
Total taxes owed: $42,000 Total taxes owed: $21,750
This hypothetical, highly simplified example compares the tax treatment of a direct rollover to moving highly appreciated employer stock as part of a lump-sum distribution. Other assets are rolled into an IRA in this example. It is very important to consult your tax adviser 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.

1Penalty taxes don't apply on distributions made after age 59½. Penalty taxes also don’t apply to distributions taken from an employer qualified plan after separation from service during or after the year in which the employee attains age 55. The 55 and separation from service exception does not apply to IRA distributions. Other limited exceptions to the 10% penalty apply, for example, payments made upon the death of the employee.
2Any available NUA tax treatment is irrevocably forfeited when employer securities are rolled over to an IRA. Current income taxes, at ordinary income tax rates, are generally due on all amounts (other than after-tax contributions) distributed from an IRA.
3Individuals who have made nondeductible employee contributions may receive net unrealized appreciation on appreciated employer securities attributable to those contributions without a lump-sum distribution.
4A participant should check with their plan sponsor to determine cost basis before a distribution is taken, because there are multiple ways that plans can elect to calculate it.
5To be considered a direct rollover and avoid the 20% mandatory withholding (which helps prepay taxes), a check or wire must be sent directly from your former employer’s plan to your IRA or a check must be made out to the IRA custodian.
6Tax rates and individual situations can change over time, for example, when a person retires and is no longer receiving wage income their tax rate can change.
7Certain exceptions to the 10% penalty may apply. The 55 and separation from service exception does not apply to IRA distributions. Please contact your tax professional regarding your individual situation.
8Many IRAs only permit publicly traded securities to be held.
9Federal bankruptcy protection afforded under the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 applies only to money rolled over from an employer sponsored plan.
10For an in-kind distribution, the employer securities are transferred from the employer plan directly to your brokerage account.
11For 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 qualified pension, profit sharing or stock bonus plan, which becomes payable to the recipient 1) on account of the employee’s death, 2) after the employee reaches age 59½; 3) on account of the employee's separation from service, or; 4) after a self-employed individual has become disabled (as defined in Code Sec. 72 (m)(7) of the Internal Revenue Code). The rules require aggregation of certain plans when making these determinations. The rules surrounding when a distribution constitutes a lump-sum distribution are complex. See your tax advisor.
12For 2023, long-term capital gains are taxed at 0% for single filers with taxable income of $44,625 or less ($89,250 married filing jointly); 15% for single filers with taxable income from $44,626 to  $492,300 ($89,251 to $553,850 married filing jointly); and 20% for single filers with over $492,300 in taxable income ( over $553,850 married filing jointly).
13The 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 a qualified retirement plan. But, of course, even if the NUA is not directly subject to the NIIT, the NUA will increase your modified adjusted gross income and could expose other income to the NIIT.
14When shares are sold, long-term capital gain tax (assumes 15% long-term capital gain tax rate) is due on any NUA (value upon distribution from the employer plan minus cost basis of the plan).  If the shares have gone down in value, the capital gain tax applies to the sales price of the shares less the cost basis.  If the shares have risen in value, then the long-term capital gain rate applies to the NUA portion and the capital gain rate on the subsequent appreciation depends on the holding period since the distribution.
Be sure you understand the potential benefits and risks of an IRA rollover or transfer before implementing. As with any decision that has tax implications, you should consult with your tax adviser prior to implementing an IRA rollover or transfer.
Ameriprise Financial, Inc. and its affiliates do not offer tax or legal advice. Consumers should consult with their tax advisor or attorney regarding their specific situation.
Investment products are not insured by the FDIC, NCUA or any federal agency, are not deposits or obligations of, or guaranteed by any financial institution, and involve investment risks including possible loss of principal and fluctuation in value.
Ameriprise Financial Services, LLC. Member FINRA and SIPC.

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