Understand net unrealized appreciation (NUA) tax strategies
- 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 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.
- 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. 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 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 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
|Direct rollover5 to an IRA — NUA tax treatment no longer available|
|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)|
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% 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)|
|$25,000 cost basis||
|$100,000 withdrawn currently with 32% ordinary federal income tax rate15||
|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.