Understand net unrealized appreciation (NUA) tax strategies
- NUA relates to distributions of employer securities from an eligible employer-based retirement plan.
- When you take a lump-sum distribution that includes employer securities, the cost basis to the plan of the securities that are distributed directly to the participant is taxable in the year of distribution from the plan.
- When securities are sold, any 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 the securities are not sold.
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 distribution1. Assets other than the portion of securities you are taking in-kind can be rolled to an IRA, but there can be no assets remaining in the employer plan. A tax advisor can help determine if the distributions qualify as lump-sum distributions.2
How does NUA work?
When you take an in-kind distribution of employer securities from your retirement plan, you - generally pay tax on the cost basis3 (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 59½.4
The shares are then held in a nonqualified brokerage account and are not taxed until you sell them. Any dividends you earn are taxable when they are paid, and are potentially eligible for special tax rates that apply for qualified dividend incomes. 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 securities.
NUA is not for everyone and makes most sense when the stock has appreciated considerably. For many people without an immediate cash need, 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 you’re holding securities that you had distributed by your plan and 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 rollover5 to an IRA — NUA tax treatment not available|
|In-kind lump-sum distribution9 of some or all of the employer securities to a taxable 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; 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.
|Tax implication||Taxes due|
|Direct rollover to an IRA — NUA tax treatment not used|
|Current income taxes due upon rollover from employer's plan||$0|
|Penalty taxes due upon rollover from employer's plan||$0|
|Current income taxes due13 upon distribution of cash from the IRA (assumes all shares have not changed in value)||$28,000|
|Total taxes due:||$28,000|
|In-kind distribution to a brokerage account — utilizes NUA tax treatment|
|Current income taxes due on the cost basis in the plan upon distribution from employer’s plan||$7,000|
|Current income taxes due14 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% long term capital gains rate10)||$11,250|
|Total taxes due:||$18,250|
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.