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 lump-sum distribution that includes appreciated employer securities, the cost basis to the plan of the securities that are directly distributed in-kind are taxable in the year of distribution from the plan.1
  • 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 while in the plan or upon distribution if the securities are not sold immediately.

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.2 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 remaining in the employer plan. A tax advisor 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 59½.5

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 income. 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 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 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 stock 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 stock as an in-kind distribution. Remember that it is risky to hold a significant portion of your retirement portfolio in one stock. A tax advisor can perform calculations to see which options could work from a tax perspective. 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 comparison

Benefits Considerations
Direct rollover to an IRA — NUA tax treatment not available
  1. Incometaxes and the potential for 10% early withdrawal penalty taxes not owed on the rollover amount.
  2. The amount rolled over, subsequent 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 taxable gains or losses.8
  5. Unlimited federal bankruptcy protection.9
  6. Eligible for Roth IRA conversion.
  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).7
  2. May pay additional 10% tax penalty for withdrawals before age 59 ½.5
  3. Subject to required minimum distributions beginning at age 70 ½.
  4. Outside of bankruptcy, creditor protection is determined by state laws.
  5. Fees may be higher in an IRA.
In-kind10 lump-sum distribution2 of some or all of the employer securities to a taxable 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 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 tax bracket and expected capital gains rates).11
  2. Required minimum distribution rules and IRS early withdrawal penalties do not apply to the NUA portion of the distribution.
  3. Dividends paid on stock may be taxable at a special long-term capital gain rate when paid.

  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
  2. May pay additional 10% tax penalty on the cost basis in the plan for distributions from the employer-sponsored plan prior to age 59½.12
  3. Must meet specific requirements to qualify for special NUA tax treatment. For example, generally only lump-sum distributions2 qualify for NUA tax treatment on qualifying employer securities.3
  4. Significant tax advantages may not be realized unless the securities have 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. Assets generally are not protected from creditors.
  7. Capital gains above the NUA amount may be subject to the 3.8% tax on net investment income.13

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 employer 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.

Assumptions Direct rollover 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 rollover6 from employer’s plan: $0
  • Current taxes due on the cost basis in the plan upon moving employer stock from employer’s plan: $8,250
$25,000 cost basis
  • Penalty taxes due upon rollover from employer’s plan: $0
  • Penalty taxes12 due on the cost basis in the plan upon moving employer stock from the employer’s plan: $2,500
$100,000 withdrawn currently
  • Federal taxes due14 upon withdrawal of cash from the IRA: $33,000
  • Current taxes15 due upon sale of stock from the brokerage account: $11,250
33% ordinary federal income tax rate16
  • Penalty taxes due if withdrawn from the IRA prior to 59 ½: $10,000
 
  Total taxes owed: $43,000 Total taxes owed: $22,000

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. Although Congress has expressed an intention to enact tax reform, until a new bill is passed by Congress and is signed into law by the President, current tax laws and regulations are used for the purposes of the estimates and analysis presented here.

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.