Understand net unrealized appreciation (NUA) tax strategies

Key Points

  • NUA relates to distributions of appreciated employer securities from an eligible employer-based retirement plan.
  • When you take a qualifying lump-sum distribution that includes appreciated employer securities, the cost basis to the plan of the securities that are directly distributed in-kind is taxable at ordinary income rates in the year of distribution from the plan. A 10% premature distribution may apply.1
  • The net unrealized appreciation is excluded from the employee’s income at the time of distribution to the extent that the securities are attributable to employer and nondeductible employee contributions. Taxation of NUA following a lump-sum distribution is deferred until the 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 shares 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 stock 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.13

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 applying 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 distribution. 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 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 surrounding when a distribution constitutes a lump-sum distribution are complex. See your tax advisor. Assets other than the portion of securities you are taking in-kind can be rolled to an IRA, but for the most part there can be no assets belonging to the employee remaining in the employer plan. A tax advisor working with the plan's administrator, can help determine if the distributions qualify as a lump-sum distribution.2,3

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 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 net unrealized appreciation 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 long-term capital gains rate on any net unrealized appreciation 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 advisor can perform calculations to see which options could work from a tax perspective.

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 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 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 beginning at age 72.
  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 distribution2 of some or all of the employer securities to a taxable brokerage account — uses NUA tax treatment (may rollover 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).11
  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 59½.1
  1. IRS early withdrawal penalties not applicable to the NUA portion of the distribution. 
  1. Must meet specific requirements to qualify for special NUA tax treatment. For example, generally only lump-sum distributions2,3 qualify for NUA tax treatment on qualifying employer securities.
  1. Dividends paid on stock can be taxable 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 generally are not protected from creditors.

 

  1. Capital gains above the NUA amount may be subject to the 3.8% tax on net investment income.12

 

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 an employee takes a lump-sum distribution upon separation from service. 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.  The taxpayer is in the 32% income tax bracket.

Assumptions Direct rollover5 to an IRA (NUA tax treatment does not apply) In-kind distribution to a taxable brokerage account (using NUA tax treatment)
Age 50
  • 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%)
$25,000 cost basis
  • 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
$100,000 withdrawn currently with 32% ordinary federal income tax rate15
  • Federal taxes due13 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 tax
  • 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 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 Penalty taxes don't apply on distributions made after age 59½. Penalty taxes also don’t apply to distributions taken from an employer qualified plan in the year the participant turned age 55 or later if separation from service occurred in the year they turned 55 or later. The 55 and separation from service exception does not apply to IRA distributions. Other limited exceptions apply.
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 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 surrounding when a distribution constitutes a lump-sum distribution are complex. See your tax advisor.
Individuals who have made nondeductible employee contributions may receive net unrealized appreciation on appreciated employer securities attributable to those contributions without a lump-sum distribution.
A participant should check with their plan sponsor to determine cost basis before a distribution is taken, because there are multiple ways that plans can calculate it.
5 To 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.
Tax rates and individual situation can change over time.
7 Certain exceptions to the 10% penalty may apply. Please contact your tax professional regarding your individual situation
Many IRAs only permit publicly traded securities to be held.
Federal 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.
10 For an in-kind distribution, the employer securities are transferred from the employer plan directly to your brokerage account.
11 For 2020, long term capital gains are taxed at 0% for single filers with taxable income of $40,000 or less ($80,000 married filing jointly); 15% for single filers with taxable income from $40,000 to $441,450 ($80,000-$496,600 married filing jointly); and 20% for single filers with over $441,450 in taxable income ($496,600 married filing jointly).
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 a qualified retirement plan.
13 Any 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.
14 When 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.
15 The 32% tax rate assumes significant taxable income from other sources.
Be sure you understand the potential benefits and risks of an IRA rollover before implementing. As with any decision that has tax implications, you should consult with your tax adviser prior to implementing an IRA rollover.
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.
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