Maximize retirement savings by utilizing Net Unrealized Appreciation (NUA)

08/23/2024 — Key takeaways:

• Net Unrealized Appreciation (NUA) is the difference between the cost basis of employer securities in a retirement plan and their market value at the time of distribution.
• NUA is not taxed as ordinary income at the time of distribution, which can offer significant tax advantages.
• Utilizing NUA can result in substantial tax savings, especially for high net worth individuals.

Net Unrealized Appreciation, or NUA, is a concept that can reduce the overall federal income tax impact of company stock distribution from employer-sponsored retirement plans. As a financial professional, understanding the NUA planning concept is essential and can be a valuable strategy for your clients’ retirement planning. This blog will explore the rules, examples, and points of discussion you can bring to your clients related to NUA.

What is NUA?

NUA refers to the difference between the cost basis of employer securities in a retirement plan and their market value at the time of distribution. When these securities are distributed in-kind from a retirement plan to a taxable brokerage account, the plan participant pays income tax at ordinary income rates on the cost basis of the shares in the year of the distribution. However, the NUA is not taxed as ordinary income at the time of distribution but rather as long-term capital gains when eventually sold, which can offer significant tax advantages.

What are the rules governing NUA?

1. Eligibility requirements: The distribution must be a lump-sum distribution following a triggering event such as separation from service, reaching age 59½, disability, or death. The distribution must include all assets from the retirement plan.
2. Tax treatment: At the time of distribution from the plan, only the cost basis of the employer stock is subject to ordinary income tax. The NUA portion is not taxed until the stock is sold and is subject to long-term capital gains tax rates even if the stock is sold soon after the distribution from the plan.
3. Subsequent appreciation: Any gains realized after the distribution on top of the NUA are taxed at short-term or long-term capital gains rates depending on the holding period post-distribution.

An example of NUA in practice

Consider this scenario:

• John, aged 60, retires from XYZ Corporation.
• His entire plan balance is $500,000.
• His 401(k) plan includes XYZ stock with a cost basis of $50,000 and a current market value of $200,000.

Distribution

• John takes an in-kind distribution of the XYZ stock to a taxable brokerage account because he retired from his employer.
• He pays ordinary income tax on the $50,000 cost basis.
• The $150,000 NUA is not taxed at the time of distribution.
• He rolls over the remaining portion of his plan balance, $300,000, to an IRA.

Sale

• When John sells the stock the $150,000 NUA is taxed at long-term capital gains rates.
• Any additional gains or losses from the date of distribution to the date of sale are taxed according to their holding period.

5 discussion points regarding your clients’ NUA

1. Tax efficiency: Utilizing NUA can result in substantial tax savings, especially for clients in higher income tax brackets.
2. Distribution strategy: Financial Professionals should evaluate if an in-kind distribution of employer stock is beneficial compared to rolling over the entire plan balance to an IRA, which could defer taxes further but result in higher ordinary income taxes upon distribution.
3. Estate planning considerations: The NUA amount is not eligible for a step-up in basis at death (under Revenue Ruling 75-125). Any increase in the stock’s value after the date of distribution from the plan will receive a step-up in basis.
4. Market conditions: Financial Professionals should consider the current market value of employer stock and the potential for future appreciation or depreciation when advising clients on NUA strategies.
5. Client circumstances: Each client’s financial situation, tax bracket, and retirement goals should be carefully reviewed to determine if the NUA strategy aligns with their overall plan.

Next steps

For financial professionals, understanding and leveraging NUA can offer a valuable tax-saving strategy for clients with employer stock in their retirement plans. By evaluating the rules, considering client-specific factors, and discussing the potential benefits and drawbacks, you can provide comprehensive guidance tailored to your clients’ needs.

Regularly reviewing clients’ retirement accounts and holdings can help identify opportunities for NUA, as well as educating them about the potential tax benefits and considerations of NUA.

Working with tax professionals can help to ensure the optimal execution of NUA strategies. By integrating NUA strategies into your practice, you have the opportunity to enhance your clients’ retirement outcomes and provide sophisticated tax planning advice.