At Granite Harbor Advisors, we believe in helping our clients better understand all of their options so they can make the best decision for their families. To that end, here is a more detailed look at what net unrealized appreciation is and how you can use it to advance your financial goals.
What is net unrealized appreciation (NUA)?
Net unrealized appreciation is simply the difference in value between the original cost basis for employer stock and its current market value. The IRS allows for special tax treatment of NUA that can be advantageous compared to rolling your 401(k) over into an IRA. Namely, NUA allows you to distribute company stock in-kind to a brokerage account and pay ordinary income tax only on the basis. You can then pay potentially lower long-term capital gains rate on the NUA when the stock is sold.
This can be valuable because distributions made from an IRA are taxed at ordinary income tax rates. So, by rolling over company stock from a 401(k) to an IRA, you would open up highly appreciated assets to ordinary income tax rates. NUA allows you to take advantage of what could potentially be more favorable capital gains rates.
So, to decide if an NUA strategy is appropriate, you essentially need to weigh the difference in paying ordinary income tax on the basis now and capital gains tax on the appreciated value later, versus paying ordinary income tax on the appreciated value in the future. However, NUA is just one of many stock compensation strategies and there are many other considerations to factor into your decision.
NUA strategy considerations
First and foremost, it’s important to understand the rules of NUA. In order to utilize NUA, you need to have a qualifying event. Those include:
- Separation from employment (Retirement)
- Reaching age 59 1/2
Some other planning considerations for using an NUA strategy include:
Age limitations – If you have not yet reached age 59 1/2, distributions of company stock may be subject to a 10% penalty.
Liquidity implications – Because you will have to pay ordinary income tax on the basis of the distributed stock immediately, you will want to make sure you have adequate cash on hand to pay those taxes.
Stock concentration – Because an NUA strategy requires you to maintain stock assets, it’s important to consider your portfolio’s stock concentration and the associated risk as it pertains to your retirement plans.
Other things to note about net unrealized appreciation
No required minimum distributions (RMDs)
- Another thing to consider before rolling your 401(k) into an IRA is that IRAs have required minimum distributions (RMDs) starting at age 72. But if you utilize an NUA strategy, company stock is removed from the qualified environment and would no longer be subject to these RMDs.
- Depending on state law, IRA assets can provide liability protection against lawsuits, liens and judgements. Once company stock is distributed out of the plan, it no longer enjoys the protections afforded by qualified assets.
Order of distributions
- Individuals can roll over non-company stock to an IRA and leave company stock in their 401(k), but the NUA has to be the last transaction involving the 401(k). An experienced firm of financial advisors can help manage the distribution or rollover process. In other words, there must be another qualifying event occurring in the future in order to leave the company stock behind.
Planning for generational wealth
- By moving company stock to a brokerage account instead of an IRA, you can enjoy more flexibility in planning for generational wealth. If company stock is passed down in your estate plans, heirs would potentially incur a smaller tax bill because assets would receive a full step-up in cost basis to market value at death. Setting heirs up for success can also help them avoid becoming part of “the sandwich generation.”
Weighing all your options
In most cases, an NUA strategy works well when company stock has appreciated significantly over time. But the rules for using NUA are complex and there are many factors to consider when trying to determine if an NUA strategy is right for you. It can be helpful to consult with a firm of experienced financial advisors to discuss whether NUA makes sense for your liquidity and tax planning needs, as well as what it would mean for your portfolio’s stock concentration. But by understanding all of your options and considering each one carefully, you can create a pathway to success and accomplish your financial goals.
Interested in learning more? Connect with Granite Harbor Advisors and we’ll set up a call to help us better understand how we can help you achieve your financial goals.