Key points
- NUA relates to distributions of employer stock from an eligible employer-based retirement plan.
- When you take an in-kind distribution, the cost basis is taxable as income.
- When sold, NUA is taxed at the long-term capital gains rate.
- You can elect not to use the NUA tax strategy.
Understand net unrealized appreciation (NUA) tax strategies
Near retirement
If you have accumulated company stock in your employer-sponsored retirement plan, you may have several options when you're eligible to take a distribution from your plan. If the stock has appreciated significantly, you may want to apply the net unrealized appreciation (NUA) tax treatment.
To do this, you must take an in-kind distribution of some or all of your employer securities as part of a lump sum distribution10. This does not mean everything that is taken has to be a taxable distribution. Assets other than the portion of stock you are taking in-kind can be rolled to an IRA, but there can be no assets remaining in the employer plan.
How does NUA work?
When you take an in-kind distribution of employer stock from your retirement plan, you generally pay tax on the cost basis (original value of the stock) of the securities at ordinary income rates in the year of the distribution. A 10% penalty may apply.
The shares are then held in a non-qualified brokerage account and are not taxed until you sell them. 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 remaining appreciation. 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 stocks.
NUA is not for everyone and makes most sense when the stock has appreciated considerably. For many people, an IRA rollover will make more sense than taking some or all of the employer stock as an in-kind distribution.
NUA tax treatment benefits and considerations
| Benefits | Considerations | |
|---|---|---|
| Direct rollover1 to an IRA — NUA tax treatment not available |
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| In-kind lump-sum distribution4 of some or all of the employer securities to a brokerage account — utilizes NUA tax treatment (rollover the rest to an IRA) |
|
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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 49; cost basis of $25,000; current value of $100,000; 33% marginal ordinary income tax rate applies to the entire distribution.
| Total taxes | |||
|---|---|---|---|
| Direct rollover to an IRA — NUA tax treatment not available | 1. Current taxes due upon distribution from employer's plan | $0 | $33,000 |
| 2. Penalty taxes due upon distribution from employer's plan | $0 | ||
| 3. Current taxes due6 upon distribution of cash from the IRA (assumes all shares are liquidated) |
$33,000 | ||
| In-kind distribution to a brokerage account — utilizes NUA tax treatment | 1. Current taxes due on the cost basis upon distribution from employer's plan | $8,250 | $22,000 |
| 2. Penalty taxes due7 on the cost basis upon distribution from employer's plan | $2,500 | ||
| 3. Current taxes due8 upon sale of stock from the brokerage account (assumes all shares are sold) | $11,250 | ||
| Potential tax savings due to NUA tax treatment | $11,000 | ||
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.
1 To be considered a direct rollover and avoid having 20% withheld from your distribution to prepay taxes, a check must be sent directly from your former employer to your IRA or a check must be made out to the IRA custodian.
2Certain exceptions to the 10% penalty may apply including an exception to the 10% penalty for distributions made to an employee who separates from services during or after the year he or she turns 55.
3 Federal bankruptcy protection afforded under the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005.
4 For an in-kind distribution, shares of the employer security are transferred from the employer plan to your brokerage account.
5 Long-term capital gains are generally taxed at a 15% rate through 2010. For taxpayers in the 10% and 5% brackets, the rate is 0% for 2008 — 2010. Beginning in 2011, the capital gains rate is scheduled o revert back to pre-2003 levels, generally a maximum rate of 20%.
6 Any available NUA tax treatment is irrevocably forfeited when employer securities are rolled over. Current taxes, at ordinary income tax rates, are generally due on all amounts (other than after-tax contributions and other basis) distributed from an IRA. Any appreciation after the distribution is subject to short-term or long-term capital gains rates depending on how long the shares are held after they're distributed.
7 Penalty taxes waived on distributions made after age 59 1/2 (and with certain criteria after age 55).
8 When shares are sold, long-term capital gains taxes (assumes 15%) are due on the NUA (current value minus cost basis).
9 Many IRAs only permit publicly traded securities to be held.
10 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 Code Sec. 401(a) qualified plan exempt from tax under Code Sec. 501(a), or code 403(a) annuity; which is payable either: 1) on account of the employee's death; 2) after the employee reaches age 59½; 3) on account of a common law employee's separation of service, or; 4) after a self-employed individual has become disabled (as defined in Code Sec. 72 (m)(7) of the annuity rules.
This information is not intended as legal or tax advice. Please consult with your legal and tax advisors regarding your individual situation.
Financial planning services and investments offered through Ameriprise Financial Services, Inc., Member FINRA and SIPC.
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